geofar - emerging financing scheme for fostering investment in the geothermal energy sector

Emerging financing scheme for fostering investment

in the geothermal energy sector

GEOTHERMAL FINANCE AND AWARENESS

IN EUROPEAN REGIONS

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IN EUROPEAN REGIONS

Emerging financing scheme for fostering investment

in the geothermal energy sector


IN EUROPEAN REGIONS

The sole responsibility for the content of this publication lies with the authors. It does not necessarily reflect the opinion of the European Communities. The European Com-mission is not responsible for any use that may be made of the information contained therein.

GEOFAR Emerging financing scheme for fostering investment in the geothermal energy sector

Abstract

Investment in renewable energy re-quires financial support from pub-lic sources, not only to overcome technical barriers and to generate economies of scale, but, also, to motivate investors to bring forward the timing of their investment, to in-vest now, rather than wait and see if they can invest later, when ener-gy prices will be even higher.

Investment in geothermal energy faces a higher timing barrier be-cause it needs to commit irrevers-ibly the bulk of its expenditure earlier than other renewables and because it needs to compensate investors for taking mining risk, a form of technical risk that can only be managed financially by pooling together a number of projects. This is an expensive and time-consum-ing process.

Public intervention to overcome the disadvantages particular to geothermal energy must target the

initial stages of geothermal energy projects, that is the exploratory and the production-drilling stage. GEO-FAR expects that an overall finan-cial envelope of a maximum of 450 million € to be committed over a five- to seven-year period may be expected to double the current rate of capital investment in geothermal energy.

Public authorities at the EU deci-sion-making level can accelerate investment in geothermal energy by providing targeted financial sup-port to suitably qualified geother-mal energy electricity-generation and heat-generation projects. The mechanism for delivering this sup-port should be a geothermal risk mitigation programme. This pro-gramme should support the early exploratory and production-drilling stages of geothermal projects. It will provide guarantees to pay a part of the costs of the exploratory and production-drilling stages of geo-

thermal projects in cases in which geothermal fluids are not found, or are found in inadequate quantity or quality. The programme should provide guarantees throughout the EU and should run for a period of five to seven years.

The governance of the programme should be along the lines of a mul-tilateral financial institution with technical assistance in the fields of geology and drilling-engineering to be drawn from a pool of experts nominated by EU Member States.A portion of the programme should be assigned to co-finance pre-feasibility studies in EU regions in which there is geothermal poten-tial, but low public awareness of that potential. Such pre-feasibility studies should be commissioned exclusively by public authorities at the local or regional level.

ABSTRACT 03


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Wind turbines and photovoltaic panels are no longer exotic gadgets. No doubt this growth is due to the rapid rise of market prices for non-renewable primary energy sources, such as oil and natural gas. Another factor in renewables growth is public policy. The public concerns about climate change and the limitations, including carbon taxation, have led public authorities to offer substantial financial support to start and sustain the growth of alternative energy.Geothermal energy has lagged behind in this process. Earlier analyses in the GEOFAR project have found many non-technical barriers to investment in geothermal energy. GEOFAR focuses on those barriers that can be removed, wholly or partially, by action at the EU decision-making level. In our understanding, if the action proposed by this project at the EU level is taken, one can expect perhaps a doubling in the rate of capital investment in geothermal energy in the five to seven years following the implementation of the policies recommended.Investment in renewable energy must overcome, not only technical barriers but, also, the cost disadvantage, before its scale of production brings its cost down to levels competitive with conventional energy. This is the motivation for offering support from public sources to such investment.The reluctance to invest in geothermal energy, relative to investing in other renewable energy sources, is stronger. Not only is drilling for geothermal fluids irreversible (one cannot close a dry well and recover any of the money spent drilling it), but most of the cost must be committed before knowing the resource is even there. Uncertainty about the price at which the energy to be produced is to be sold is complemented with uncertainty about potential cost overruns in drilling the production wells.To illustrate the arguments calling for support of geothermal energy, we present the investment options facing investors in a typical 5MWel electricity-generating geothermal plant1. Just paying investors, by means of a feed-in tariff, to undertake the investment immediately, would call for a feed-in tariff of at least 170 €/MWhel, without taking into account the risk of dry holes or of drilling-cost overruns. Over the

lifetime of such a station, consumers would be called to pay about 20 million € more for their electricity over the cost of a modern natural-gas-fired, combined cycle plant. Of course, consumers are already paying such renewable energy premiums for other forms of renewable energy and, sometimes, those premiums are significantly higher. Total capital investment in such a station would need to rise to 30 million €.Geothermal resources can be used for generating heat and, if the thermal capacity (based on temperature and flow rate) and quality of the resource happens to be sufficient, for generating base load electricity. In some cases, joint production of electricity and marketable heat energy is possible. It is important to realise that the scale of geothermal electricity projects is, on average, significantly larger than the scale of heat projects. This means that capital costs for electricity projects are, on average, three to four times larger than they are for heat projects. The risks are, also, correspondingly higher, as the flow rate is decisive factor, which depends strongly on the geological situation, i.e. transmissivity of the reservoir. On the other hand, the expected benefits, both environmental and financial, can be correspondingly higher for electricity-generating projects.GEOFAR recommends a balanced approach in supporting both larger-scale (electricity generating) and smaller-scale (heat-supply) projects. This is the standard approach to capacity planning in energy. Moreover, the EU endowment in geothermal resources consists of few electricity-capable geothermal fields. Concentrating investment on them may appear to promise rapid, if finite, progress in developing geothermal energy. However, such concentration also concentrates the risks. Therefore, GEOFAR favours geothermal energy development by many small lower-risk steps. Heat-capable geothermal fields are more numerous, their wells need to be drilled at shallower depths and cost less to drill. Their risks are correspondingly lower. Those smaller-scale projects should add up to a significant proportion of the geothermal investments portfolio.To overcome the aforementioned handicaps of geothermal

Introduction

Introduction 04

Renewable energy sources have seen rapid growth in the last five years. Capital investment, installed power and energy produced have increased, but so has public awareness of their presence and achievements.

1 This is a reference plant. The scale of actual plants is closely related to the size of the geothermal resource.


energy relative to other forms of renewable energy, GEOFAR recommends targeting significant financial support from public sources to the initial, exploratory and production-well drilling stages of qualifying geothermal projects. To increase the flow of qualifying geothermal projects beyond the medium term, especially in EU Member States in Eastern and Southern Europe, GEOFAR proposes financing partly from public sources small-scale pre-feasibility and feasibility studies.GEOFAR outlines three delivery mechanisms for such support, all coming under the management of a Geothermal Risk Mitigation (GeoRiMi) programme.

Instrument I proposes co-financing prefeasibility studies to be commissioned exclusively by regional and local authorities in areas with geothermal potential in which public awareness of that potential is inadequate.Instrument II proposes extending partial guarantees to the exploratory stage of qualified geothermal energy projects.Instrument III proposes extending partial guarantees to the production-drilling stage of qualified geothermal energy sources.The geothermal energy risk mitigation programme should run in all EU Member States, cover both electricity-generation and heat-generation projects and run for between five and seven years.

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Table of contents

Abstract 1

Introduction 4

Contents 6

List of Figures 8

List of Tables 9

1 Main advantages of geothermal energy – Stylised macro facts EU 10

1.1 Main advantages of geothermal energy – Stylised macro facts EU 10

1.1.1 Price stability and security of energy supply 11

1.1.2 Reduction of greenhouse gas emissions 13

1.2 Status of geothermal energy- Stylised macro facts in selected EU Member States 16

1.2.1 District heating in France 16

1.2.2 District heating in Germany 17

1.2.3 District heating in Hungary 17

1.2.4 Synthesis 18

1.3 Status of geothermal energy-Micro facts in selected geothermal projects 19

Sample projects of deep geothermal energy 19

1.3.1 Borehole heat exchanger at the RWTH Aachen 19

1.3.2 Hydro-thermal site at Simbach-Braunau (Germany/Austria) 20

1.3.3 Hydro-thermal installation at Unterschleißheim (Germany) 20

1.3.4 Cogeneration of heat and power at Altheim (Austria) 20

1.3.5 Cogeneration of heat and power at Unterhaching (Germany) 21

1.3.6 Hydro-thermal installation at the Paris-Basin (France) 21

1.3.7 Power generation in the Azores (Portugal) 21

1.3.8 Synthesis 21

2 Main barriers in geothermal energy projects - Analysis of needs for financial support 22

2.1 Legal security 23

2.2 Limited basic geological research data 23

2.3 Small-scale of plants 23

2.4 High risk of drilling for high-energy geothermal resource High up-front costs of geothermal energy plants 24

2.4.1 Output-price risk 24

2.4.2 Risk of non-discovery 26

2.4.3 Resource-discovery risk – Drilling cost overruns 28

2.4.4 Investment timing risk – Irreversibility 29

2.4.5 Economic factors determining investment in geothermal energy 33

2.4.5.1 Projected revenues flows 33

2.4.5.2 The cost of investment 33


2.4.5.3 The discount rate 33

2.4.5.4 The growth prospects rate 33

2.4.5.5 The volatility rate 35

2.4.5.6 The subsidy or premium to ensure immediate investment 35

2.4.6 Extension to the heat-generation option 36

2.5 Varied legal and policy environment in EU Member States 37

2.6 Awareness issues 37

2.7 Generation costs of heat using geothermal energy 37

2.7.1 Factors determining heat generation costs 37

2.7.2 Calculation of heat generation costs of geothermal energy 39

2.7.3 Comparison of the heat generation costs Fossil-fuels versus Geothermal 41

2.8 Conclusions 42

3 A Geothermal Risk Mitigation (GeoRiMi) programme 44

3.1 Principles of operation 44

3.2 Reasoning 44

3.3 Operation of the geothermal guarantees mechanism 45

3.3.1 Decision-making and management structure of the geothermal guarantees mechanism 46

3.3.2 Revenues and expenses of the Geothermal Risk Mitigation Programme 46

3.3.3 Aligning interests in the Geothermal Risk Mitigation Programme 47

3.4 Summary of financial flows 48

3.5 Insurability 50

4 Instrument I 51

4.1 Awareness - Needs for Financial Support 51

4.2 Description of Instrument I 51

4.2.1 Objectives of Instrument I 51

4.2.2 Target group 52

4.2.3 Eligible costs 52

5 Instrument II 53

6 Instrument III 55

Conclusions 56

7 Draft GeoRiMi constitutive document 57

8 Projected GeoRiMi Financial flows 59

Appendix: A high-enthalpy geothermal power plant 64


Figure 1-1 Primary energy consumption and production by fuel in the EU-27 p. 10Figure 1-2 Import Prices of Hydrocarbons to Europe p. 11Figure 1-3 Forecast of fossil fuel imports of the EU in the year 2030 p. 12Figure 1-4 Contribution of renewable energy sources to final energy consumption in the EU

27p. 12

Figure 1-5 CO2 emissions for power generation p. 13Figure 1-6 CO2 reduction factor for power generation in Germany p. 14Figure 1-7 CO2 emissions of fossil fuels for heat generation p. 14Figure 1-8 Additional value for the reduction of CO2 emissions p. 15Figure 1-9 Geothermal resources potential in France p. 16Figure 1-10 Geothermal resources potential in Germany p. 17Figure 1-11 Geothermal resources potential in Hungary p. 17Figure 1-12 Share of heat generation sources p. 18Figure 1-13 Draft of the borehole heat exchanger Aachen p. 18Figure 1-14 Overview of the drillings at Simbach/Braunau p. 20Figure 2-1 Energy price more volatile than other prices p. 24Figure 2-2 Relative price of primary energy p. 25Figure 2-3 Volatility of the real price of primary energy p. 25Figure 2-4 Relationship between Profitability, Flow rate of water and Probability of success p. 27Figure 2-5 Investment Timing (Zero Premium) p. 30Figure 2-6 Investment Timing (35% Premium) p. 30Figure 2-7 Investment Timing (67% Premium) p. 30Figure 2-8 Value of investment opportunity; No growth prospects; No risk p. 31Figure 2-9 Value of investment opportunity; 2% per year growth prospects; No risk p. 31Figure 2-10 Value of investment opportunity; 2% per year growth prospects; 12.5% risk p. 32Figure 2-11 Euro yield curve p. 34Figure 2-12 Factors determining heat generation costs p. 38Figure 2-13 Annual load duration curve p. 39Figure 2-14 Heat generation costs of sample projects p. 39Figure 2-15 Structure of heat generation costs from geothermal energy as per plant capacity p. 40Figure 2-16 Structure of heat generation costs from geothermal energy Sensitivity to interest

ratep. 41

Figure 2-17 Heat Generation Costs Comparison p. 42Figure 3-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory

and drillingp. 49

Figure 3-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds – exploratory and drilling

p. 50

Figure 5-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory only

p. 53

Figure 5-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds – exploratory only

p. 54

Figure 6-1 Geothermal Risk Mitigation Programme Flows of investment funds – drilling only p. 55Figure 6-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds

– drilling onlyp. 56

Figure A-1 The geothermal power plant at Pico Vermelho, Azores, Portugal p. 64

List of Figures


List of Tables

Table 1-1 Baseline Prices of Fossil Fuels p.11Table 2-1 Probability that the cost overrun overcomes the expected present value of 5 million

Euros in the hypothetical scenario examinedp.28

Table 2-2 Premium required over breakeven for a 30 million € investment in a geothermal electricity-generating plant under alternative scenarios of growth prospects and volatility

p.32

Table 3-1 Time-profile of the operation of the Geothermal Risk Mitigation Programme p.48Table 3-2 Effects of success rate on funding flows p.49


MAIN ADVANTAGES of GEOTHERMAL ENERGY10

1. Main advantages of geothermal energy

1.1 Main Advantages of geothermal energy - Stylised Macro facts EU

Renewable energy is energy deriving from natural resources such as sunlight, wind, rain, tides, and geothermal heat, which are renewable. As Figure 1-1 shows, renewable energy sources (RES) still provide only a small share of the total primary energy consumption in the European Union. Nevertheless, the share of RES increased from 1997 to 2007 from 5% to 8%.

Figure 1-1 Primary energy consumption and production by fuel in the EU-272

Geothermal energy is power extracted from heat stored within the earth. It is a renewable energy source with high potential. It offers many advantages to its users:

Price stability and security of supply relative to fossil fuels.Reduced greenhouse gas emissions for power generation as well as for heat generation.Diversification of energy supply. Reduced dependency on fossil-fuel or nuclear base-load sources, no

intermittence of supply unlike other renewables.Less impact on the environment owing to the small size of geothermal power plants relative to other renewable

energy installations. Suitable to connect to existing district heating networks at low conversion cost.

2 Eurostat (2009), “Energy, transport and environment indicators”, pp. 29 and 31.


MAIN ADVANTAGES of GEOTHERMAL ENERGY 11

1.1.1 Price stability and security of energy supply

This section deals with the price stability and security of energy supply stemming from the use of geothermal energy. Geothermal energy has several advantages in comparison to other energy sources, in particular fossil fuels:

Geothermal energy is available 24 hours a day and can be used as base-load energy supply. The generation costs are more stable than those of energy generated from fossil fuels.

The European Commission expects a rapid rise in fossil-fuel prices for the next twenty years in comparison with prices in the year 2005. The forecast until 2030 is illustrated below in Table 1-1. The figures suggest that in particular the prices for oil and gas will rise substantially in real terms in the next twenty years. In the case of oil, an increase of 15% in the real oil price is expected. For gas prices, the European Commission projects an even higher rise in the real price of 38% in comparison to the prices of 2005.

2005 $ / boe 2005 2010 2015 2020 2025 2030

Oil 54,5 54,5 57,9 61,1 62,3 62,8

Gas 34,6 41,5 43,4 46,0 47,2 47,6

Coal 14,8 13,7 14,3 14,7 14,8 14,9

Table 1-1 Baseline Prices of Fossil Fuels3

Figure 1-2 below illustrates the expected prices of hydrocarbons and, additionally, shows the volatility of fossil fuels prices of the last twenty years.

Figure 1-2 Import Prices of Hydrocarbons to Europe4

Another fact to be taken into consideration is the dependency on energy imports, which is shown in Figure 1-3. As oil, gas and coal reserves are unevenly distributed around the globe, Europe is heavily dependent on non-EU countries for its future supply of those fossil fuels5. In 2000 EU overall energy dependency was about 50% and will rise to approximately 70% in 2030, if no action is taken. However, a shift towards renewable energies, geothermal energy in particular, can reduce this dependency.

3 See Eurostat Report “European Energy and Transport – Trends to 2030”, p. 28.4 See Eurostat Report “European Energy and Transport – Trends to 2030”, p. 29.5 See EurActiv: http://www.euractiv.com/en/energy/geopolitics-eu-energy-supply/article-142665.



Oil and gas, the two main energy sources for the generation of heat, will have to be imported mostly from non-European countries. Today 45% of EU oil imports originate from the Middle East and as forecasted by the EC, by 2030, 90% of EU oil consumption will have to be covered by imports. Gas imports originate mainly from Russia (40%), Algeria (30%) and Norway (25%) and by 2030, it is estimated that over 60% of EU gas imports will come from Russia and in total more than 80% of gas imports will come from outside the EU. By 2030, it is also expected that 66% of the demand for coal will have to be covered by imports.

Because of the soaring costs of hydrocarbons, the volatility of prices and the forecasted import dependency, it is obvious that fossil fuels should be substituted by other energy sources. As geothermal energy presents a reliable and clean energy source that can be used for the generation of base load energy for heat and electricity it seems to be a good substitute for hydrocarbons. Therefore, it should play a more important role in the future energy mix of the European Union Member States. In fact, it has already a significant role in the renewable energies mix. Figure 1-4 shows that a considerable part of the renewable energy produced in the EU is used in the form of heat. The bulk of the heat generated from renewable energy sources comes from geothermal energy. The role of other renewables in heat generation is minimal. Geothermal energy is the most straightforward way to meet heat energy needs from renewable energy sources. This can be achieved by providing limited, suitably targeted support from publicly-funded financing sources to investment in geothermal energy.

Figure 1-3 Forecast of fossil fuel imports of the EU in the year 2030

Figure 1-4 Contribution of renewable energy sources to final energy consumption in the EU-276

6 European Environment Agency (http://www.eea.europa.eu/data-and-maps/figures/contribution-of-renewable-energy-sources-to-primary-energy-consumption-in-the-eu-27)

Biofuels consumptionRenewable electricity consumption (normalised)Renewable heat consumption

Note: Hydropower was calculated according to the new methodology proposed in the CARE package (15-year average). it is important to note that the final methodology may be subject to further changes.

Source:Eurostat



1.1.2 Reduction of greenhouse gas emissions

About 60% of the total CO2 emissions in the EU are emitted from burning fossil fuels to generate heat for heating buildings7. Therefore, the installation of geothermal plants will reduce Greenhouse Gases (GHG) emissions in the EU by substituting fossil fuels and thus providing a clean and reliable source of energy. Geothermal energy can not only generate heat but also electricity. Thus, from a purely environmental point of view, geothermal energy is the perfect energy source to reduce GHG emissions. The figures below shall underline the GHG emissions reduction potential of geothermal energy.8 By comparing several studies concerning CO2 emissions by using different sources of energy, Klobasa and Ragwitz concluded that power generation by geothermal is the most effective way to reduce CO2 emissions as it can be used as base load electricity and thus can replace coal power plants. Figure 1-5 illustrates the CO2 emissions per kilowatt hour of electricity of several energy sources. The figure shows that geothermal energy has the lowest CO2 emissions.

Figure 1-5 CO2 emissions for power generation

The reduction factor of a renewable energy source can not be completely calculated by the figures above. The reduction factor shows how much CO2 can be mitigated per kWh by using renewable energies in comparison to other energy sources. Not every renewable energy source can be used as base load energy and therefore the type of the power plant which is replaced by a renewable energy power plant, is different. From this point of view, geothermal energy seems to be the perfect energy source, as it provides both heat and electricity reliably and therefore can replace big coal power plants which have the biggest share of the CO2 emissions due to power and heat generation. Only hydro energy, of which nearly all resources in Europe are already in use, has a similar reduction factor. The CO2 emitted per average kWhel differs from country to country. In France, for example, the CO2 emission factor is relatively low due to the high proportion of nuclear power, whereas in Germany, CO2 emissions per kWhel are relatively high due to the high proportion of coal-fired power plants.The reduction factor of geothermal energy in Germany is: 1030 g/kWhel. The CO2 reduction factors are illustrated in Figure 1-6. In France, those reduction factors for power generation are significantly lower and could even be 0 g/kWhel.

7 See http://www.superc.rwth-aachen.de/cms/front_content.php?idcat=4 8 The following figures are mainly taken from the report of Klobasa/Ragwitz of the Fraunhofer Institute for Research on Innovation

(2005), “CO2-Minderung im Stromsektor durch den Einsatz erneuerbarer Energien”.



Figure 1-6 CO2 reduction factor for power generation in Germany

The heat provided by geothermal energy can be used as base load energy for district heating networks. Thus, these installations can be used to replace fossil fuel fired installations and reduce CO2 emissions substantially. Figure 1-7 illustrates the CO2 emissions of fossil fuels generating heat and thus shows the reduction potential of geothermal energy.

Figure 1-7 CO2 emissions of fossil fuels for heat generation9

Assessing the CO2 emissions for geothermal energy is rather difficult, as many different factors have to be considered. One of the most important factors is the electricity needed for the water circulation and the size of the geothermal installation.Therefore, the CO2 emissions of geothermal energy providing heat are estimated to 10 g/kWhth

10. The German Federal Environmental Agency assesses the reduction factor of geothermal energy when replacing fossil fuels for heat generation to 229 g/kWhth.11

The reduction factor of geothermal energy generating power is much higher than the reduction factor of heat generation. However, the heat generation option merits special consideration for the following reasons:

1. The heat market has a higher share of primary energy consumption than electricity. 2. The resources for high-enthalpy geothermal energy in Europe that are suitable for electricity generation are

relatively few in comparison with resources outside the EU.3. There are many district heating networks already in use, in which geothermal energy can directly substitute

fossil fuels.4. Other renewables cannot provide heat energy as readily and as cheaply as geothermal energy.


MAIN ADVANTAGES of GEOTHERMAL ENERGY

Following the argumentation of the “Stern review on the Economics of Climate Change” for each ton of CO2 emitted, a certain price should be included in calculating the full social costs of different sources of energy. Thus, apart from the environmental gain from the reduction of CO2 emissions when using geothermal energy or other emissions-free energy,12

for each ton of CO2 not emitted, in comparing production cost with energy from fossil fuels a certain amount has to be considered. Either it must be added to the cost of fossil-fuel energy, or it must be subtracted from the cost of emissions-free energy. The Stern Review assesses this amount to be 85 €/t CO2. Other reports, e.g. the one elaborated by Krewitt and Schlomann in the year 2006, assess the costs to be rather 70 €/t CO2

13. This figure has to be included in the calculation of heat generation costs. Figure 1-8 illustrates the additional value for the reduction of CO2 emissions per MWh for both, heat and power generation. The amount is multiplied by the CO2 reduction factor mentioned above.

Figure 1-8 Additional value for the reduction of CO2 emissions

Environmental costs do not enter into the calculations of private investors and of their financial backers. However, it is the duty of public authorities to take them into account in shaping their support mechanisms. In a sense, support mechanisms must externalise the environmental benefits of renewable energy sources, so as to attract private capital and thus remedy a market failure and lead to truly efficient use of scarce resources. In terms of reduced CO2 emissions, geothermal power can, based on the findings illustrated in Figure 1-8, claim support of between 70 and 90 €/MWhel (for electricity generation) and between 17 and 30 €/MWhth (for heating).This analysis of the environmental costs and benefits of geothermal energy leaves out the important factor of risk. This approach oversimplifies the analysis. The experience with capacity planning in the energy sector shows that there are very long time periods, especially following energy crises and financial crises, when the optimal path for building energy capacity is to forego large high-risk projects and focus on incremental capacity additions. Therefore, the choice of large-scale (electricity-generation) or smaller-scale (heat generation) projects is not a priori clear and must be dynamically adjusted in response to conditions in the energy market and the financial markets.

15

9 See University of Göttingen: www.uni-goettingen.de/de/79037.html10 Other sources assume CO2 emissions of 27 g/kWhth. See Forschungstelle für Eneuerbare Energien (website http://www.ffe.de/

taetigkeitsfelder/ganzheitliche-energie-emissions-und-kostenanalysen/211-geothermie-freiham)11 German Federal Environmental Agency (Bundesumweltbundesamt) (2005), Erneuerbare Energien – Einstieg in die Zukunft, p. 8.12 The Stern Review can be found at http://www.hm-treasury.gov.uk/stern_review_report.htm.13 Ingenieurbüro für Erneuerbare Energien, “Nutzen durch erneuerbare Energien im Jahr 2008”, p7. See http://erneuerbare-ener-

gien.de/files/pdfs/allgemein/application/pdf/nutzen_ee_2008_bf.pdf


1.2 Status of geothermal energy – Stylised macro facts in selected EU Member States

Many European countries14 already have extensive networks of district heating (DH) and, thus, by being economically viable, geothermal energy can substitute fossil fuels in those networks. This will be illustrated by examples of some European countries. They are typical, in many respects, of conditions in the whole of Europe.15

1.2.1 District heating in FranceFrance, especially the northern regions, has a rather high demand for heat. Consequently, France supported the development of geothermal energy particularly in the Paris Basin during the oil crises in the 1970s and 1980s. Nowadays, 27% of the total heat delivered to DH networks is generated by renewable energy sources and 11% of this is generated by geothermal energy. In 2009, 29 geothermal district heating networks with a total installed capacity of 240 MWth were running in the Paris Basin. In total, there are about 425 district heating networks with a total installed capacity of 17,442 MWth and about 2 million French households are connected to DH networks. The industry makes an annual turnover of about 1.25 billion € delivering a total district heat of 80,078 TJ (that is an average price of 56.2 €/MWhth). As nearly 70% of district heat is still provided by fossil fuels, such as coal, natural gas and oil, there is still a great potential for substituting these environmentally unfriendly technologies by geothermal energy. The objectives set are to increase the production of direct uses from geothermal energy (DH) by 370 Ktoe to 2020 (2006: 130 Ktoe, 2020: 500 Ktoe).16

As shown in the map below, much of the potential of geothermal energy is close to the major population centres, but as much is found in relatively remote areas, such as the Massif Central, where the heat generated would, perhaps, have difficulty finding buyers immediately.

Figure 1-9 Geothermal resources potential in France


14 For a short overview of the geological characteristics of France, Germany, Greece, Portugal, Spain, Hungary, Bulgaria and Slovakia (the GEOFAR project target countries) see the GEOFAR Report “Non-technical barriers and the respective situation of the geother-mal energy sector in selected countries”.

15 The data is taken from the statistics published by the Euroheat & Power Association of the year 2007 (for further information see: http://www.euroheat.org/District-heating-cooling-4.aspx) and the GEOFAR Report “Non-technical barriers and the respective situa-tion of the geothermal energy sector in selected countries”

16 See: www.legrenelle-environnement.fr/IMG/pdf/rapport_final_comop_10.pdf


1.2.2 District heating in Germany

The German heat market is one of the largest DH markets with a total installed capacity of 57.000 MWth. As the exploitation of geothermal energy started already in the 1970s there are some DH networks fed by geothermal energy although geothermal energy resources can not be found in all regions of Germany.About 4.9 million households are connected to DH networks and receive a total amount of about 267.171 TJ per year, which leads to a turnover of around 16 billion € (that is an average price of 215,6 €/MWhth). Although there is such a high heat demand, the share of renewable energies generating heat for DH networks, including geothermal energy, is still only 10%. The current capacity of geothermal energy installations regarding heat generation is about 100 MWth.

Figure 1-10 Geothermal resources potential in Germany

1.2.3 District heating in Hungary

Hungary, like many Eastern European countries, disposes of a large number of DH networks17. In total, there are 92 DH networks operating with an installed capacity of 9.722 MWth. These networks deliver about 44.835 TJ of heat to more than 650.000 households. Although Hungary disposes of some of the largest reserves of geothermal energy in Europe, only a share of 8% of the overall heat consumption is provided by renewable energies while more than 80% of the district heat is generated by natural gas. Industry turnover is around 0,74 billion € (that is an average price of 59,5 €/MWhth).

Wells in sandstoneWells in carbonate

Figure 1-11 Geothermal resources potential in Hungary


17 http://www.iea-gia.org/documents/SzanyiKovacsHungaryExperience-draftAxelsson4Apr09.pdf


1.2.4 Synthesis

Figure 1-12 illustrates that the share of renewable energies used for district heating, especially geothermal energy, is very small. If geothermal energy received support commensurate with its environmental benefits, it would become economically competitive and there would be huge potential for geothermal energy to substitute fossil fuels not only in Eastern European countries, but also in Western European countries like France and Germany. The valuation of the environmental benefits of geothermal energy is, therefore, an important matter as has been already shown in section 1.1.2 above.

Figure 1-12 Share of heat generation sources

One could point to many reasons why the utilisation of renewable energy and geothermal energy for district heating varies so much among Member States. The findings of the GEOFAR project (see Report “Non-technical barriers and the respective situation of the geothermal energy sector in selected countries”) pointed out the lack of awareness for geothermal energy among decision makers. As an attempt to remedy this discrepancy between received opinion and reality, a number of sample deep geothermal energy projects are presented below, focusing on the record of high reliability and maturity of a few real-world geothermal energy projects.



1.3 Status of geothermal energy – Micro facts in selected geothermal projects

Sample projects of deep geothermal energy

While many heat markets in the European Union still rely on heat produced by fossil fuels such as oil, gas and coal, there are already many geothermal energy projects in various European countries which are providing heat, and sometimes also electricity, to thousands of households. These projects prove the feasibility and reliability of geothermal energy and its contribution to the reduction of GHG emissions in the European Union. Some of those sample projects are listed below.In order to get an idea of the economics of geothermal plants below, one should bear in mind the following guidelines. They are a rough outline of the investment appraisal process of the European Investment Bank (EIB). They are only a rough guide, because geothermal projects are so diverse. Moreover, the economics of geothermal investment are analysed in depth in section 2 below.The basis for evaluating mature renewable energy projects is the least cost fossil-fuel alternative. This is a Combined Cycle Gas Turbine at 55% efficiency. The capital costs of such a plant augmented with the fuel cost, a hefty CO2 premium and a security-of-supply surcharge led to an alternative cost of 72€/MWhel. In mid-2007, this was already a large increase over a cost of 50€/MWhel in mid-2005. Moreover, the prospect of further increases in the CO2 premium and forward pricing for what the EIB expects to be the marginal mature renewables technology in 2020 led the EIB to adopt a figure of 80€/MWh as its target price for electricity to be generated from mature renewables. The upheaval in the energy markets in 2007 and 2008 has led the EIB to revise the figure further upwards to 96€/MWhel. In sum, to qualify for EIB financing, a geothermal energy electricity-generation project must return 5% or more over 15 years at an assumed price of 96€/MWhel or lower for the generated electricity.The reference figures for electricity imply reference figures for heat energy between 24 and 32 €/MWhth.

1.3.1 Borehole heat exchanger at the RWTH Aachen

A good example of the practicability of a borehole heat exchanger is the installation at the University of Aachen in Germany. In this region the conditions for geothermal energy are not favourable for installing hydro-thermal applications. Still, a borehole heat exchanger can be an economically viable investment when assuming a high increase in fossil fuel prices in the future. In the year 2004 the University of Aachen started to drill a 2.500 m deep borehole in order to install a borehole heat exchanger providing heat to the student service centre18. The total investment sum was 5,1 million €, installing a capacity of 450 kWth at an operating temperature of 70°C. The total heat generation is about 620 MWhth per year. Reported capital costs, assuming a rate of return of 5%, are 411 €/ΜWhth per year or 567.000 €/ΜWth per year. One should, however, note that the implied rate of utilisation of this facility is only 1377 hours per year. The facility was built with a focus on developing technology and not on commercial operation.In order to maximize the effectiveness of the installation, the borehole heat exchanger is used to cool the buildings during the hot summer periods. This type of installation can be installed in any region in the EU and thus shows the applicability of geothermal energy in any heating and cooling system within the EU.

Figure 1-13 Draft of the borehole

heat exchanger Aachen19


18 See http://www.superc.rwth-aachen.de/cms/front_content.php?idcat=4 19 See http://www.superc.rwth-aachen.de/cms/front_content.php?idcat=4


1.3.2 Hydro-thermal site at Simbach-Braunau (Germany/Austria)

The geothermal energy project of Simbach-Branau is a perfect example of European partnership as the project is providing energy to two cities in different countries and due to its success new investments in the DH network were initiated.The drillings for the geothermal energy project of Simbach-Braunau were started in 1999 and were finished in 2001. The plant provides heat for the district heating network of the two cities of Simbach (Germany) and Braunau (Austria). With an installed capacity of 5,4 MWth the installation provides heat for the district heating network with a capacity of up to 40 MWhth

20. Buildings like the local hospital and fire department are connected to the 22 km DH network. The depth of the two drillings is 1.848 m respectively 1.947 m carrying water with a temperature of up to 80°C21.

Figure 1-14 Overview of the drillingsat Simbach/Braunau22

1.3.3 Hydro-thermal installation at Unterschleißheim (Germany)Another sample project is the geothermal energy plant of “Unterschleißheim”. It took only 4 years from the first ideas to realize such a project until the two drillings were completed23.In 2002, the first drilling of the geothermal energy project resulted in finding thermal water in a depth of 1.961 m with a reservoir temperature of 81°C. The drilling costs of nearly 8 million € and the identification of the reservoir led to a total investment of 21 million €. By installing this geothermal energy plant with a capacity of 27 MWth, a significant reduction of GHG emissions could be achieved. Capital costs, assuming a rate of return of 5%, are 38.900 €/ΜWth per year. It annually saves 8.600 tons of CO2 emissions as well as 4,5 tons of SO2 and 7,9 tons of NOX. The capital costs per ton of CO2 emissions saved is 122 €/ton. This is high, considering figures lower than 20 €/ton calculated in section 1.1.2 above.

1.3.4 Cogeneration of heat and power at Altheim (Austria)The geothermal energy project of Altheim is a very special one as the heat generation has been operating since 1990. In 2000, an Organic Rankine Cycle (ORC) installation was added and Altheim became the first geothermal energy power plant in Central Europe24.

The first steps to install the geothermal energy plant for heating were already taken in 1986 and in 1989 the contracts were concluded. Due to the high risk of such a project and the little experience at that time, the local municipality had difficulties in finding an insurance company, but finally two companies from Austria and Hungary took the risk. The total investment for the 2,5 MWth installed capacity was 1,9 million €, a reinjection well was not built. Today the installation has a capacity of 11 MWth. The depth of the drilling is about 2.300 m, where a water temperature of about 106°C is registered.In the year 2000 the installation was extended, adding a reinjection well as well as an ORC-turbine to generate electricity and thus enhancing the profitability of the whole project. By adding new investment costs of 5 million €, a turbine with an electric capacity of 1.000 kWel was installed, providing up to 2.000 MWhel per year. The implied utilisation rate is 2000 hours per year.The combination of heat and power generation is a perfect example of how geothermal power projects can take place: in the first stage, wells for the supply of the district heating network are drilled verifying the assumed potential. If the temperature and the flow rate are sufficient, a turbine can be added to the installation. The option to increase capacity and scope of a project incrementally, where this is possible, is a desirable feature of investment projects.



1.3.5 Cogeneration of heat and power at Unterhaching (Germany)The geothermal energy project of Unterhaching is a true success story25. The special purpose vehicle to undertake this project was founded in 2002 and it took only seven years to finalize the whole geothermal energy project. Rödl & Partner was assigned to manage the whole project and achieved to obtain a drilling risk assurance in the year 2003. This insurance solution lowered the risk for the project significantly and thus drillings could be started.The drillings in the year 2004 and 2005 concluded in finding hydrothermal reserves of up to 133,7 °C and a flow rate of up to 150 l/s, which was a huge success. The depth of the first drilling is 3.350 m and for the second drilling is 3.590 m. The installed capacity of the plant will be a total of 70 MWth which will be delivered by a newly built district heating network. Moreover, in order to generate electricity a so-called Kalina cycle was added to the installation to produce about 21.500 MWhel per year. The installed capacity is 3,36 MWel. It is planned to generate up to 126 GWhth of heat per year and distribute it through the district heating network. The capital invested so far sums up to 80 million €.Many other German municipalities followed the example of Unterhaching and try to develop their own geothermal projects in order to become more independent from energy imports.

1.3.6 Hydro-thermal installation at the Paris-Basin (France)The geothermal energy installations of Chevilly-Larue and L’haÿ-les-Roses have been providing energy to the two cities since 1985 and the district heating network is one of the biggest geothermal district heating networks in Europe.With an installed capacity of about 27 MWth the installation provides heat for the district heating network of up to 85 GWhth (2004)26. Two geothermal doublets are exploiting a thermal water of 74°C and the users are connected in cascade to a 22 km DH network feeding more than 22.000 households units. The depth of both drillings is 2.000 m carrying water with a temperature of up to 80°C.

1.3.7 Power generation in the Azores (Portugal)Portugal disposes of high-energy resources located at Portugal’s islands, especially the Azores. They are suitable for geothermal power generation. Since 1980, geothermal electricity is produced in Sao Miguel Island, Azores. In December 2006, the Pico Vermelho plant started and replaced the 3 MW pilot unit which was operating since 1980. The Pico Vermelho power plant is served by five geothermal production wells and two injection wells. Maximum temperatures recorded at this sector of the field are between 235ºC and 240ºC. The most productive horizons of geothermal fluid are between 500 and 800 meters deep. The geothermal production wells have an average flow rate of 120 tons/hour. The installed power is 10 MWel, however the power output of the plant has been consistently more than 11 MWel. The annual production is approximately 97 GWhel. The total investment costs for the power plant and drilling of geothermal wells were 34 million €. Capital costs, assuming a rate of return of 5%, are 17,6 €/ΜWhel per year or 154.500 €/ΜWel per year27.The case of the Pico Vermelho plant shows the capacity of geothermal power to provide highly reliable base load electricity. This is especially valuable in a peripheral location such as the Azores and could be viable, even if the cost were not as low as in the Azores with its favourable geology.

1.3.8 SynthesisAll the projects outlined above show the practicability of geothermal energy projects. One should note how varied the circumstances of those projects are, suggesting that geothermal energy can be versatile in meeting diverse energy needs. In Europe, given presently available technology, one should expect most geothermal development to be directed at the generation of heat, as there are only few high-enthalpy resources which are suitable for electricity generation. Nevertheless, due to the high amount of low-enthalpy resources and the large number of already existing district heating networks, there is significant potential for geothermal energy to provide heat to many thousands of households.

20 See http://www.simbach.de/p/d1.asp?artikel_id=1029 21 See http://www.braunau.at/gemeindeamt/html/4ax.htm22 See http://www.simbach.de/p/d1.asp?artikel_id=1029 23 See http://www.unterschleissheim.de/index.html?xml=/gtuAG/projekt.xml24 http://www.altheim.ooe.gv.at/system/web/zeitung.aspx?menuonr=218375019&detailonr=21814972725 For further information see: http://www.geothermie-unterhaching.de/ and http://www.geothermieprojekte.de/projektbeispiel-unter-

haching-1/projektanfang 26 Seehttp://www.semhach.fr/semhach02.htm 27 For a more detailed description of the Pico Vermelho plant, please see the Appendix



Notwithstanding its many advantages, investment in geothermal energy lags behind in comparison to other types of renewable energy. GEOFAR has identified non-technical barriers that stand in the way of geothermal energy investment. They can be overcome by limited, targeted public intervention that will encourage increased investment in geothermal energy. It is up to the public authorities, at the EU and lower decision-making levels, to assess whether the specific public benefits of investment in a geothermal energy project or class of projects are worth the costs of public intervention.The GEOFAR project focuses on medium-depth and deep geothermal energy. In the experience of the project partners, confirmed by the information provided by geothermal experts in one-on-one meetings, and by the technical and financial information gathered for the GEOFAR project, the large and diffuse energy potential of shallow low-energy geothermal sources is and can be sufficiently tapped by means of existing market and non-market mechanisms.The identified barriers to further development of geothermal energy in the GEOFAR target countries are grouped in three major groups: technical, financial and other. The terms of reference for the present project do not include an analysis of technical barriers. One should keep in mind, however, the findings of GEOFAR that technical barriers, as perceived by investors, public officials and the public, are a significant factor in explaining the present stage of slow development in the field of geothermal energy. Moreover, GEOFAR findings show that technical barriers generally arise in combination with non-technical barriers. Since the end-purpose of the GEOFAR project is to lead to concrete and practical proposals to quicken the pace of investment in geothermal energy, the distinction between technical and non-technical barriers, made for purposes of analysis, will not be so stark in this document.

The primary obstacles to the development of geothermal energy projects identified by GEOFAR are the following:- Legal uncertainty over the ownership and the rights of ownership of a geothermal resource- Mainly in Eastern and Southern Europe, limited availability of basic geological research data and high cost of

obtaining new data.- Diffuse nature of low-energy geothermal resource, requiring many small-scale plants. Some plants happen to

lie close to where energy is needed. Others don’t.- High risk (relative to other renewables) of drilling for high-energy geothermal resource - High up-front costs

of geothermal energy plants. At EU level, the scale and risk problems are compounded by a legal and policy environment that varies greatly from one Member State to another.

- Low awareness of geothermal energy benefits among investors, public officials and the public.

As it will become clear below the barriers to the development of geothermal energy are strikingly similar to the problems faced by the fossil fuels extracting industries, such as coal-mining and oil-drilling in the very early days of their development. The similarities have been repeatedly pointed out by the experts interviewed in one-on-one meetings conducted in the framework of GEOFAR. The crucial difference is that those industries had a much longer time in which to mature, during which the demand for their output grew steadily together with supply. In the case of geothermal energy, demand is already at a high level. Because of the present-day climate problems, however, a long (century-scale) time frame for development of the supply is not feasible. Climate science does not give the world that much time. Issues about the availability and security of fossil-fuel supply, also, point towards investing now in diversified portfolio of alternative energy sources. It follows that speeding up geothermal development requires a conscious decision by policy makers to devote significant resources to the task. Geothermal energy is not merely CO2-neutral but almost CO2-free. This advantage should be appropriately valued by policy makers.Just finding information on an industry at an early stage of its development is not an easy task. In the GEOFAR study, the information was gathered by significant and costly effort by the project partners. All of it has been checked and confirmed. This process was followed by all the GEOFAR project partners because they all understood that the information was gathered to support decisions and not merely to reach research conclusions.Let us examine now each of the primary obstacles to development of geothermal energy listed above.Before proceeding, one should note that the goal of accelerating geothermal investment in the short to medium term cannot be reconciled with removing barriers to geothermal development that need addressing over the longer term. Moreover, it is not clear what action at the EU level can remove obstacles at the local level, for example local opposition that mining activities often arouse. Local authorities and operators have found out that, once fear in a community has been aroused, the time and resources needed to quell it render the project infeasible for at least a generation.

2. Main barriers in geothermal energy projects - Analysis of needs for financial support

MAIN BARRIERS in GEOTHERMAL ENERGY PROJECTS22


2.1 Legal security

The question of ownership of renewable natural resources has not been resolved satisfactorily neither in the academic field of law, nor in the academic field of economics. Some natural resources can be owned by economic agents and some can’t. Even those that are owned, find their use regulated by public policy, at times strictly. The case of water, a resource with universal use, illustrates this point. Water ownership and use arouses controversy virtually everywhere in the world. What does not work in theory, often works in practice. Researchers have been able to observe very elaborate systems of intertwined legal and economic practices that allow communities to share scarce renewable natural resources, for example irrigation water, with astounding gains in economic efficiency. Unfortunately, such systems are developed over several decades and defy general applicability.In general, in most developed countries the mining codes concerning geothermal fluids have been updated to reflect recent technological developments. Still, the issues of dual use, for example medical/touristic versus heating/electricity generation, still arise. In part, this is due to the nature of the geothermal resource. Unless one drills, it is not known what precise use the geothermal fluid, if found, can be put to. Thus, besides the risk of a dry hole, the operator runs the risk of overstepping the terms of the drilling license. The license-granting authority, on the other hand, has the impossible task of weighing the costs to a community of drilling against the benefit that can range from negative to tens of millions of euro. Thus, the terms of a license that seemed sufficient to an operator, may turn out too restrictive in the light of drilling results.It is impossible to devise a legal system to address this problem, even if it were possible, much less to have it adopted throughout the EU. A partial remedy would be to facilitate financially public research organisations that would, then, direct their effort to unearthing the minimum research information needed for an efficient licensing process. Even so, the legal impediments will only be lowered, not eliminated, and this would cost dearly in money and time.

2.2 Limited basic geological research data

In the absence of a well-funded full-scale geological research programme, basic geological research data in Southern and Eastern European countries have been obtained as a by-product of test-drilling for oil or gas or of test-drilling for water. Private investment in basic research data is unlikely to be on a sufficient scale, since the benefits of it are not flowing exclusively to the investor. For example, who would be prepared to buy data on a dry hole and at what price? Why should the entity generating this data bother about retaining it, putting it into useable form and making it available to potential competitors? Even if the overall interest of society were to be served, the agents have no interest in furthering it. Therefore, public intervention in the shape of financing research-drilling is needed to remedy this deficiency. Public research funds are not free, however. Test-drilling for geothermal energy must compete with numerous other worthwhile research proposals in the field of energy from renewable sources, in the broader field of energy and in many other basic research fields. Thus, overcoming the data availability barrier means primarily moving geothermal area further upwards in the policy agenda, both at the EU and the Member-States. But public provision can be complemented in three ways:First, a drastic expansion of shallow drilling, properly monitored, will provide data and greatly expand the number of engineering professionals with experience in drilling and geothermal energy.Second, the packaging of licenses to develop geothermal resources in sizes large enough, in both the geographical and the geological and economic sense, to ensure that the licensee can be reasonably hopeful of finding “some” significant source of energy, can attract private funding for basic geological research.Third, public-private partnerships, as dictated by the prevalent financial and policy environment, properly structured, may provide the means to resolve the twin problems of setting proper priorities and financing basic geological research.

2.3 Small-scale of plants

The present state of technology clearly does not allow geothermal energy to provide large-scale power stations, such as is possible with fossil fuels and, even, large hydroelectric plants. There is promise in the Enhanced Geothermal Systems (EGS) technology, but there are very significant technology barriers to be overcome, before it is commercially mature. The value of pursuing EGS technology is, at present, the option value of a future and uncertain gain.The scale limitation is a limitation affecting all renewable energy sources being developed at present. Geothermal energy, however, differs. Solar panels and wind turbines can be manufactured in a central location in large quantities, thus capturing very significant economies of scale. They can, then, be deployed in the field. Sometimes, they can be deployed exactly where there is demand. On the other hand, geothermal resources, especially high- and medium-energy ones, are site-

MAIN BARRIERS in GEOTHERMAL ENERGY PROJECTS 23


specific. One could argue that each geothermal field requires knowledge specific to it alone to be developed.The scale problem is well-known in the mining industry. Not all quantities of minerals are economical to mine. Some are present in small quantities in a given geographical location, while others have small concentrations and yet others lie too far from where they could be usefully processed. Moreover, the processes of extraction and refining very often differ radically from one site to another.To overcome this barrier, policy makers should aim for a two-pronged approach, one for low-energy geothermal resources and one for medium- and high-energy ones.Low-energy geothermal resources can be developed using technology that can be mass-produced. This production can be simulated by encouraging (even mandating through the building code) geothermal heating and cooling in buildings in high density areas in order to mitigate primarily both local warming and, by saving on energy consumption, global warming.Medium- and high-energy geothermal resources are handicapped by their small scale. However, small scale is not always and everywhere a handicap. From the point of view of regional development, development of energy resources particular to each region is highly desirable. Moreover, geothermal energy has a much smaller environmental footprint than solar or wind energy. Therefore, the absence of significant economies of scale may not be the most important consideration for public policy makers when choosing to support a geothermal energy project.All the primary obstacles listed under points 1 to 6 in the beginning of this chapter need addressing, if geothermal energy is to be developed at a level closer to its potential. However, not all those difficulties can be analysed quantitatively. We do believe though, that the issues of drilling risk and front-loading of costs (point 4) can be analysed quantitatively. For this reason, the analysis of those two issues takes much more space and time than the analysis of the other issues. This is needed in order to bring the readers/users of this report to a common starting point so as to follow the line of argument from beginning to end.

2.4 High risk of drilling for high-energy geothermal resource High up-front costs of geothermal energy plants

2.4.1 Output-price riskThe matter of risk is the most important in the energy sector overall. But there are many kinds of risks and one needs to make distinctions between one kind of risk and another. Let us look into this issue by first developing some analytical tools that will help us analyse each of the different types of risk.The most visible type of risk in the energy industry is the output-price risk. This is shown in the graph below (Figure 2-1):

Figure 2-1 Energy price more volatile

than other prices



We are looking at the price of primary energy, that is, mainly, the price of oil, gas and coal. It is remarkable that the price of energy relative to all goods and services stands today at about the level it was in 1982. However, the level of the price of energy has stayed lower than the price level of all goods and services over most of the last 36 years. On the other hand, for almost six years (2003-2009) energy prices outpaced the overall price level.

It is worth looking deeper at the relative price of energy that is at its price compared to all goods and services. It is shown in the graph that follows (Figure 2-2):

If one chooses to discern a trend into the data graphed above, one would arrive at a growth rate of about 2% per year. Since this rate has been adjusted by a measure of the general (producer) price level, this figure is a measure of the real appreciation in the price of primary energy over the last 36 years.

The graph, also, illustrates the problem of investing for the long run in primary energy. An investment made in 1986 on the expectation of price growth along the 2% trend would have had to withstand 16 years of below-trend prices. It is worth noting that even investment in energy conservation, such as in better insulation of buildings, has suffered from the high volatility in the price of energy.There is yet more complexity in the energy output-price risk puzzle. One notices that in recent years the real price of en-ergy is not only higher than in years past, but that it is also more volatile: It has more violent ups and downs. How much more violent? One can consider the following graph (Figure 2-3):

Figure 2-2 Relative price of primary energy

Figure 2-3 Volatility of the real price

of primary energy



Observed volatility has been increasing over time in the period 1979-2009. Thus, the problem of an energy investor, whether in the private or in the public sector is not one-dimensional. Forecasting the likely long-run trend of the price of energy is not enough. An investor must also plan for increasing price volatility. As the graph above shows, volatility does not go to infinity. But its ultimate upper bound is probably unknowable.

We have produced a set of simulations for the path of the price of energy over a period equal to the period examined. The simulations were designed to exhibit the same statistical properties as the actual prices, allowing, of course for a sizable random component, just as we observe in actual energy prices.

The practical conclusion of this exercise is that a house owner who saved 3000 Euros by not insulating the roof of his house in the aftermath of the oil crises of 1974 and 1979 is better off today than an identical house owner which did invest in insulating his roof. Worse, he or she would be better off in two thirds of the cases, even if energy prices had developed otherwise.

The analysis so far illustrates clearly why some stability of the price at which energy is sold is so crucial to undertaking any investment in the energy sector, be it in fossil-fuelled energy, in renewable energy or in energy conservation. Setting and guaranteeing a feed-tariff is therefore a very important instrument for promoting investment in energy. Ensuring out-put price stability is equally important in business policy in the private sector and in public policy in the public sector. This is why so much energy is traded under medium- and long-term contracts.

What is perhaps not so clear in public debate is the size of the implicit subsidy in a guaranteed feed-tariff. To reduce the chances of non-recovery of an investment undertaken in the terms we have examined in the roof-insulation example above to, say, 25% from 64% would take a subsidy of almost half the cost of the investment in insulation. In other words, granting a subsidy covering 50% of the investment cost would remove more than half of the risk.

The real question though is: Will this reduction in risk be enough or more than enough to make the investment attractive? We need additional analytical tools to answer that question and these are developed later in this section.

On the other hand, we must note that a guaranteed price set to be paid for the entire life of an investment in energy means that the rate of return for the investor need not be large. If that price is guaranteed by the state, the rate of return for the investors need only be as high as the rate of return on state bonds of a similar maturity profile.

What about diversification? Would output-price risk be reduced for an investor that invested a small part of his or her total investment funds in each project? The answer is no, if investment is diversified in portfolios of many energy projects, whether renewable or non-renewable or conservation-only. Out of an infinite number of scenarios that one can generate for the next 25 years, only one will come to pass. If prices are low for most of the next 25 years, then they will be low for all the energy investments in one’s investment portfolio and the return on that portfolio will be low.

What about diversification into other sectors of the economy? High primary energy prices have often been blamed for triggering declines in world economic activity, so they would appear to be strongly countercyclical. This popular view, is, however, strongly refuted looking closer. Energy prices are strong signals of changes in the direction of the path of economic activity, but once this change of direction has occurred, energy prices follow. So energy investments in prac-tice carry little systematic risk, the risk of moving up and down with the whole economy. Thus, they can, in theory, fit into well-diversified investment portfolios that will diversify away their high idiosyncratic risk. Geothermal energy investments, however, are not yet mature enough in the perception of investors, nor are they so numerous as to allow this risk-mitiga-tion technique to apply.

2.4.2 Risk of non-discovery

The commercial use of deep hydro geothermal energy for heat and/or electricity generation depends on finding suitable “geothermal hotspots” beneath the earth. Several examples across Europe showed that finding such a suitable “geothermal hotspot” is not guaranteed. The risk connected to a successful exploration is also considered as a discovery risk. The discovery risk is defined in particular as the risk28 of not achieving a thermal output capacity from a geothermal reservoir by one (or more) well(s) in sufficient quantity or quality29. In other words, not to achieve the required thermal capacity from


28 In fact it is a risk during the exploration of the resource and therefore often related to as “exploration risk”. In GEOFAR we wanted to clarify the expression and therefore talk about the “discovery risk” as defined.

29 Dr. Rüdiger Schulz, Basic Requirements for an assessment of probability of success for hydrogeothermal wells


one or more production wells. This discovery risk can either be the risk of non-discovery (i.e. complete failure) or a partial discovery (partial success). The discovery risk in deep geothermal energy projects concerns mainly hydro geothermal wells. As most deep geothermal energy projects currently running in Europe are based on hydro geothermal resources the discovery risk together with the high upfront costs are the main barriers for the development of geothermal energy projects across Europe.In each hydro geothermal project the assessment of the discovery risk is the central question for investors and decision makers. In fact a “probability of success” is defined for particular cases, including usually a base case, a partial success case and failure. For each case and for each particular project this assessment will have to be conducted to enable the appraisal of the risk-reward-ratio for the investor. This risk-reward-ratio also can be expressed in the profitability of the project. The profitability of the project therefore relates directly with the found amount of water (as a carrier of the energy) in relation to the probability of success (see also the diagram in Figure 2-4). If a minimum profitability (depending on investor) cannot be achieved, in general the project is considered to be not economic viable.

Figure 2-4 Relationship between Profitability, Flow rate of water and Probability of success

Consequently a failed drilling will lead to a complete loss of investment (for drilling, exploration activities and planning). Partial success could mean, that with capital coming from insurance (as insured event) that a further utilization of the drilling will be able (reaching a minimum profitability). Success leads to a further project development as planned.A good quantitative assessment of the discovery risks by geoscientists – the common tool is a seismic analysis - can limit the discovery risk. But, the seismic analysis cannot fully eliminate the risk of no or not sufficient discovery of resources. More important are also drillings at nearby locations, which usually help to define the temperature and the general transmissivity of the reservoir, but for a new drilling it is always essential to assess the particular location to identify e.g. karstified structures (with cracks, etc.) which are zones for higher transmissivity.If an unsuccessful well has to be abandoned, investments for the drilling works (including project development and planning) are in most cases to be considered to be lost. Nevertheless, investments of often more than EUR 10 million per project are subject to this particular risk. The investor must acquire capital to move the geothermal project from the first steps into later stages of development, and the investor(s) must be willing to finance at significant risk.The first injected equity has to be considered to be venture capital. Foreign capital at this stage is almost impossible to acquire, as financing institutes surely will not deal with any discovery risk (this shows also the practical approach of the European Investment Bank (EIB), which rejects application of financing for drilling phases of geothermal projects, but is willed to finance later phases which could be e.g. the construction of district heating network or power plants.)Consequently the projects lack of financing of these early project stages. Europe wide there is a gap in available financing instruments – if not public supported mechanism are available – that correlates to the highest risk period of project



development phases (early stage of the project when the resource is not proven and the risk of non-discovery is very high), each investor has to face a disproportionate share of project risk compared to other renewable energy investments. One can state that the upfront costs associated with geothermal exploration and drilling require a major financial commitment by investors in the face of a risk that a confirmation drilling may fail to identify an economically viable prospect, even when the extensive seismic analysis indicate the potential for encountering a viable geothermal resource. Mitigating the risk by a public instrument paves the way for geothermal project with all their advantages. Currently, only a few European countries provide a risk-mitigation system on insurance-basis for geothermal projects in order to overcome this barrier. These are France, the oldest one, Switzerland and Germany. At international level, the GeoFund (handled by the World Bank) provides also a partial insurance system for GeoFund member countries whereof Eastern European countries like i.e. Bulgaria can benefit from. But the access is limited to just a small share of geothermal energy projects across Europe and up to now there was only one projected “insured” by the Geofund-mechanism.To boost the European geothermal sector within a particular time frame as a whole a Europe-wide risk mitigation system could be one solution.

2.4.3 Resource-discovery risk – Drilling cost overruns

Geothermal energy projects do not face only output-price risk. The cost of finding and accessing the geothermal resource cannot be known in advance. This fact introduces another risk factor in the decision to invest.In the course of the GEOFAR project information on several specific proposed projects has been gathered. Some of that information has been presented above. Other information was gathered in meetings but in the understanding that it would not be published in its original form or that it would be published in depersonalised form, or that it would be published without attribution. However, it was found that the technology of geothermal electricity-generating plants is now so well defined that no appreciable differences were found in the several projects examined. Therefore, the analysis will proceed on a hypothetical example plant. The scale can vary in the case of larger or smaller plants, but the economic characteristics will stay the same.Let us, therefore, start with a hypothetical project with an investment budget of 30 million €, a time horizon of 25 years and guaranteed net revenue of 2 million € per year over the life of the project. Assuming no uncertainty over the investment budget, those baseline assumptions yield a modest net present value of 5 million €. But we cannot be sure that no cost overruns will be encountered.We are modelling the percentage of cost overruns by means of a beta distribution. It is a very versatile probability distribution that allows us to examine different scenarios. We assume that a geothermal energy project will have cost overruns starting at 0% and going up to a maximum value. Experts interviewed for the GEOFAR project, seem to suggest that the maximum cost overruns is about 40%, after which, presumably, the project is abandoned, but we can use any reasonable upper bound number. We can assume that the probability of incurring a cost overrun of size x (0<x<maximum) is uniform over the interval [0, maximum]. We can assume that the probability of a cost overrun of size x declines with the size of the cost overrun at a constant rate. We can, also, assume that the probability of a cost overrun of size x declines faster than the rate at which the size of the cost overrun grows. All those cases and more can be modelled as instances of the beta distribution.How often will the cost overrun overcome the expected present value of 5 million € in our hypothetical scenario? This probability is shown in the Table 2-1 below:

Maximum cost

overrun

beta parameter

1 2 4 10

10.00% 0.0% 0.0% 0.0% 0.0%20.00% 16.8% 2.6% 0.0% 0.0%30.00% 47.3% 19.0% 4.2% 0.0%40.00% 59.3% 35.3% 11.2% 0.6%

Table 2-1 Probability that the cost overrun overcomes the expected present value of 5 million € in the hypothetical scenario examined



NATIONAL INSTRUMENTS28

It is clear that the risk associated with cost overruns in building a geothermal energy project can be significant. This risk is not affecting investments in other renewable energy projects nor, even, investments in energy projects in general. It is important to note that this is technical risk of the kind that can be mitigated by pooling together as many projects as possible. This observation explains the ever increasing size of companies in the mining sector, where resource-discovery risk is high

2.4.4 Investment timing risk – Irreversibility

Let us now turn on the matter of investment timing.Investment projects, including projects in geothermal energy, may be viewed as options that can be exercised now or at any time in the future. Assuming the goal of public policy is to accelerate development of geothermal energy projects, what are the conditions that will encourage project developers to invest now, rather than in the future?Let us consider the example of a 5MWel geothermal plant generating electricity30. The total investment cost of building such a plant, including the cost of drilling, is about 30 million €. Current technology allows such plants to operate for 8000 hours per year for a minimum of 15 years. The capital costs of such a plant, assuming a discount rate of 5% per year are 73€/MWhel. With operating costs of 23€/MWhel, one arrives at a break-even cost of 96€/MWhel. It is clear that, under such circumstances, investment in geothermal energy cannot be very attractive to investors. There does not appear to be a significant margin left over, after all the costs have been paid. However, this conclusion needs qualification.1. The price for the electricity produced is high, if one compares it to fossil-fuel-fired electricity-generating plants. It

does, however, exactly meet the criterion adopted by the European Investment Bank (EIB): 96€/MWhel for plants generating electricity from renewable energy sources. This figure has been provided by officials from the Lending and Projects Departments of the EIB during the exploratory meeting the GEOFAR WP3Leader had with them at the Bank’s Headquarters, in February 2009, for the purpose of presenting the GEOFAR project.

2. Electricity prices for certain other sources of renewable energy are, in some countries, considerably higher. Photovoltaic panel plants receive over 450€/MWhel in Greece, and other solar plants over 250€/MWhel. However, such high prices are largely justified by the economies of scale that manufacturers of solar plants of all kinds have promised and, in significant part, already delivered.

3. There is potential for revenue enhancement, where demand for the excess heat released by the plant exists near the plant.

4. Regional conditions favour the building of geothermal plants in remote locations, such as in islands, where shipping energy from afar is uneconomical. Regional policy may, in such instances, provide additional incentives.

5. Assuming a long-term contract for the sale of electricity can be negotiated, a geothermal plant can be financed by debt, thus allowing a higher return for equity investors. In such a case, however, the return for the equity investors is not paid for by the operation of the plant, but by the erosion of the return of debt investors.

But our example plant cannot be reasonably expected to operate in a static world. After all, climate change is expected to drive upwards the real price of energy. Might not the plant be more profitable, if one factors in the prospect of higher energy prices in the future? Assuming a growth in the real price of energy produced by the plant grows by 2% per year, the breakeven cost of the plant falls by 9.4% to 87€/MWhel. So, should investors who believe that the price of energy will continue rising in the long run invest now? The surprising answer is “no”! 31

Investors seeking a higher return may find it more advantageous to invest in the plant not immediately, but later. The graph in Figure 2-5 below summarises the choices available to a potential investor in our plant. Clearly, the maximum profit is not to be earned by investing immediately, but by waiting for about 25 years! The maximum profit is to be earned by investing after about 25 years.

30 This is a reference plant. The scale of actual plants is closely related to the size of the geothermal resource. For approximately similar figures from an actual plant, please see the Appendix.

31 Dixit, A.K. & R.S. Pindyck (1994): Investment under Uncertainty Princeton University Press, Princeton, N.J., 1994 Most of the analysis of investment timing under uncertainly in this section draws on the findings of this study. The seminal paper in

this field of economics is: The Value of Waiting to Invest, Robert McDonald; Daniel Siegel, The Quarterly Journal of Economics, Vol. 101, No. 4. (Nov., 1986), pp. 707-728.



Figure 2-5 Investment Timing (Zero Premium)

The prospect of higher energy prices in the future makes investment in energy both more profitable, but, also, more remote! In an extreme case, if the growth rate rose to a level close to the discount rate, one could hardly expect any investment! The prospect of growth increases the value of an investment project, but, at the same time, makes it less likely that this same project will be undertaken immediately.Suppose, however, that this investor were to be offered a premium for investing now. How would that affect the decision to invest and how high would that premium have to be?As one can see in the following graph (Figure 2-6), a premium of 35% of the cost of the plant would bring the optimal time for investing forward. Maximum profits are to be earned after about “only” 12 years.

Figure 2-6 Investment Timing (35% Premium)Present Value of funds flows (discount rate = 5%)

Figure 2-7 Investment Timing (67% Premium)Present Value of funds flows (discount rate = 5%)



But it would take a premium of 67% to bring the investment forward to the present (Figure 2-7).So, if it were to be agreed that, for reasons of public policy, it were desirable to accelerate the rate of investment in geothermal energy, one may use the framework developed so far to get an approximate hold on the need and the size of additional support that would be needed.Our analysis of investment timing is appropriate for a dynamic but certain world. We have assumed that energy will be getting more and more expensive. Experience shows, however, that there exist long periods during which the real price of primary energy is stable or, even, falling. This fact turns out to have a significant influence on investment timing. We illustrate this risk effect by extending our example of the electricity generating geothermal power station.

Figure 2-8 Value of investment opportunityno growth prospects and no risk

Figure 2-9 Value of investment opportunity growth prospects (2% per year) and no risk

The graph in Figure 2-8 shows the value of the opportunity to invest in our geothermal project, in a world with no growth prospect and no risk. It shows how much a rational investor would be prepared to pay to acquire this investment opportunity, given the present value of revenues from the project net of operating costs.As long as the present value of revenues from the project net of operating costs is less that the total capital cost of the plant, the investment opportunity has no value whatsoever. As soon as the present value of revenues from the project net of operating costs exceeds the total capital cost of the plant, the investment opportunity is given by subtracting the total capital cost of the plant from the present value of revenues from the project net of operating costs. The critical point for the investment decision is shown by the vertical dotted line.Introducing growth prospects changes the picture. As one can see in the graph above (Figure 2-9), the kinked line (shown in red) showing the value of the investment opportunity becomes a curve (shown in blue) and shifts upward. The critical point that the present value of revenues from the project net of operating costs must reach for immediate investment is the point of tangency shown by the vertical dotted line. It is at a significantly higher level than the one required for immediate investment in the no-growth-prospects and no-risk case.Proceeding to the next step, we introduce risk. The following graph (Figure 2-10) below shows that the curve showing the value of the investment opportunity shifts further upwards. Once again the critical point of the present value of revenues from the project net of operating costs at which one can expect immediate investment is even higher, and significantly higher, than in the case of growth prospects and no-risk.



Figure 2-10 Value of investment opportu nity; 2% per year growth prospects; 12.5% risk

Table 2-2 below shows the premium required to get investment started as a percentage of the assumed break-even revenue of 30 million €. For example, assuming a discount rate of 5%, growth prospects of 2% per year and revenues volatility of 5% per year, our geothermal plant would need a premium of 76.3% over the break-even revenue of 30 million € to get going, i.e. it would require support of over 22.5 million €.

Discount rate = 5% (real)

Volatility Growth prospects (real)0.0% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50%

0.00% 0.02% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 900.00%2.50% 8.24% 16.11% 28.52% 45.70% 69.21% 102.47% 152.59% 236.30% 403.90% 906.94%3.00% 9.96% 17.75% 29.89% 46.89% 70.30% 103.54% 153.71% 237.60% 405.61% 909.99%3.50% 11.71% 19.46% 31.41% 48.24% 71.56% 104.79% 155.04% 239.12% 407.63% 913.59%4.00% 13.49% 21.25% 33.05% 49.74% 72.99% 106.21% 156.56% 240.88% 409.95% 917.74%4.50% 15.29% 23.10% 34.80% 51.38% 74.57% 107.81% 158.26% 242.86% 412.58% 922.45%5.00% 17.12% 25.00% 36.65% 53.15% 76.29% 109.56% 160.15% 245.07% 415.51% 927.69%10.00% 37.03% 46.25% 58.77% 75.95% 100.00% 134.83% 188.28% 278.63% 460.85% 1009.90%

Table 2-2 Premium required over breakeven for a 30 million € investment in a geothermal electricity-generating plant under alternative scenarios of growth prospects and volatility

Clearly these are very substantial amounts, especially in cases of high volatility. The purpose of feed-in tariffs is precisely to reduce the high primary-energy price volatility to a manageable size. However, the real price of primary energy is determined by the nominal price fixed by the feed-in tariff and the rate of general price inflation. The rate of inflation is determined by broader macroeconomic factors, so a remainder of volatility must always be assumed in investment calculations. One should, also, note that macroeconomic volatility is irreducible by diversification or other financial operations.


present value of revenues net of operating costs - million €


2.4.5 Economic factors determining investment in geothermal energy

At this point let us present a summary of the economic factors that determine investment in geothermal energy:1. The projected revenues flows2. The cost of investment3. The discount rate4. The growth prospects rate5. The volatility rate and6. The subsidy or premium to ensure immediate investment

We must choose appropriate values for each one of those variables to arrive at a baseline projection of the investment path one can expect by pursuing a policy aimed at encouraging investment in geothermal energy. This investment path will be spelled out in terms of capacity, cost and time.

2.4.5.1 Projected revenues flowsElectricity- and heat-generating geothermal plants have a record of reliable continuous operation. Therefore, variation in revenues derives, mainly, from variation in output price. One would expect high energy prices to precede additions to generating capacity. It is important to note that electricity is a regulated market and, therefore, changes in world energy prices do not translate automatically into higher electricity prices. In fact, increases in primary energy prices first show up as increased costs of generation rather than as increased profits.

2.4.5.2 The cost of investmentThis variable is determined by engineering studies. In terms of economics, it is important to recognise that the total cost for an electricity-generating geothermal project is disbursed in three distinct stages. These are:

a) the initial exploratory studies (seismic and similar) of a diagnostic nature. They cost about 1 million Euros. If they are successful, the project proceeds to theb) drilling stage (exploratory and production) costing between 5 and 10 million Euros. If this stage is successful, one proceeds to thec) building stage costing about 20 million Euros

It is clear that the most critical stage is the drilling stage. It requires a large investment with a high probability of partial or total failure. Moreover, the risk is of a technical nature. There is no way this risk can be mitigated by the ordinary financial tools available to a project operator. The only way to know the cost of the drilling stage is to do the drilling.The problem is known in the extractive industries and their experience shows that high-risk venture capital investors cannot provide significant financing. The most productive approach is to pool the risk by building big companies that own many projects and can compensate for the failure of some projects with resources drawn from other projects that are successful.Therefore, a financing scheme for this stage of geothermal projects should mimic this technique for pooling the drilling-stage risks.

2.4.5.3 The discount rateThe rate shows the preference of an investor (including public entities in their capacity as investors) for a flow of resources to run in the present as opposed to flowing at a specified time in the future. It is a very important and very controversial figure in any discussion, theoretical or practical, of investment.One approach is to set it exogenously to reflect the preferences of the investor for present over future enjoyment. Another approach suggests setting it following the signals of the financial markets. In the last two to three years the turmoil in the financial markets has shown serious weaknesses in this approach. However, one must accept that over the long-term, such as the one considered for investments examined in this report, financial markets will operate and provide credible signals. Then the discount rate will be determined by taking the risk-free rate of interest and adding a risk premium equal to the average rate of return on the universe of all the investment assets (the market rate of return) net of the risk-free rate of interest multiplied by the correlation of the rate of return on the particular investment with the market rate of return.



Essentially this so-called Capital Assets Pricing Model suggests that well-diversified investors need only earn a rate of return that reflects the risk that they cannot reduce by spreading their investments over many projects in different sectors of the economy. Thus, they are supposed to cover their macroeconomic risk, the risk they can do nothing about.The rate of return on investments in energy is weakly correlated, if at all, with the market rate of return. Thus, in times of normally functioning capital markets, one should expect to find investors in energy projects who would be willing to earn a rate of return close to the risk-free rate of interest.If one is willing to assume complete futures markets in energy for long periods (over 10 years), then the discount rate should be set at the risk-free rate of interest. Most analysts would think this is unrealistic. Still energy is actively traded in financial markets, so this argument gives an indication as to the value of the discount rate.With financial markets not functioning, the correlation of returns in all classes of assets is nearly perfect. In that case, the discount rate must be set at a rate equal to the market rate of return. This rate is hardly constant. The researchers’ findings of historical rates as high as 8% (real) cannot be used in this instance, since it has been calculated mostly from data obtained in periods of normal operation of financial markets. So, on this argument, too, one must end up with a discount rate close to the risk-free rate.The graph in Figure 2-11 shows the spot risk-free rate for public-sector entities borrowing in euro. The data are nominal, but the prospective inflation as measured and perceived by the financial markets does not seem to be significant. Thus, the real risk-free rate of return cannot show a significantly different picture.

Figure 2-11 Euro yield curve32

On the basis of the data and the discussion above, the preferred value for the discount rate that this analysis proposes is 5%. It will be shown later on in this section of the report that the choice of this value is critical and if, in reality, the true value turns out significantly different, the findings can be very severely weakened.To illustrate, consider the example 30 million Euros geothermal electricity-generating plant. All other variables being equal (growth prospects 2%, volatility 6%), passing from a discount rate of 5% to 4% raises the subsidy warranted for immediate investment from 24 million Euros to 35 million Euros.


years to maturity

23 Nov 2009 - source: European Central Ban


2.4.5.4 The growth prospects rateAs the analysis so far has shown this is also a very significant variable and one rarely taken into account. Its measured average value of real growth around 2% over the last 35 years (please see Figure 2-2 above) cannot be a basis for a safe prediction over the next 15 or 20 years.One should rather base a prediction on the assumption that public policies to restrain emissions from the burning of fossil fuels will drive the cost of generating energy from those sources higher and higher over the years. In the absence of a major technological breakthrough, one should be confident that such a scenario is, indeed the most likely outcome.As in the case of the discount rate, an illustration of the effect of the choice of the particular value for this variable shows that passing from a growth prospects rate of 2% to a rate of 2.5% raises the subsidy warranted for immediate investment from 24 million € to 34 million €.

2.4.5.5 The volatility rateVolatility is an important variable for the short term. High output prices lead to spurts of immediate investment in the expectation that high prices will persist, as indeed they often (but not always) do for a number of time periods.In the longer term, high volatility means that extreme price movements in one direction in one time period are likely to be cancelled out by strong price changes in the other direction in subsequent time periods. Thus, annual volatility of 26% per year, as observed in the price of primary energy in the last 36 years, is transformed to a total volatility of around 3% for a project that will run for 15-20 years.However, an arithmetically correct value of 3% appears too rosy in view of the fairly strong turbulence observed in the real, as well as in the financial, markets. This study will propose a value of 6%.Passing from a volatility rate of 3% to 6% raises the subsidy warranted for immediate investment in our example geothermal electricity-generating plant from 21 million € to 24 million €.

2.4.5.6 The subsidy or premium to ensure immediate investmentThis review of the market variables that determine investment in geothermal energy shows that immediate investment in geothermal energy requires support at a level significantly beyond the one that is presently available through feed-in tariffs. It is for the public authorities to judge whether the environmental and other benefits of geothermal energy warrant increasing the feed-in tariff for this type of project by the equivalent of about 80% (discount rate 5%, growth prospects rate 2%, volatility rate 6%) over its present level.This is a fairly high level of support. It is high in absolute terms and in terms of the support provided for most (though not all) alternative forms of renewable energy. To illustrate, if the public authorities chose to deploy this support solely through a feed-in tariff, then this tariff would have to be set at around 170€/MWhel .The support that would be provided through such a high feed-in tariff over the lifetime of our example geothermal electricity generating plant would total 24 million € in present value terms. And it would mobilise private investment of 30 million €. So, this policy would be one of low additionality for the public financial resources that would be committed to it. Fortunately, there are better and cheaper ways to deploy public support, as we shall show below.We start by observing that the risk-return characteristics of the project are quite different for the three stages of our example geothermal project. Once the exploratory and drilling stages are completed, the building stage is much less risky. In fact, a private investor who would be given the opportunity to invest 20 million € in the building, and receive a feed-in tariff of 90-96€/MWh would earn around 9-10% per annum on the 20 million € invested. If that investor financed two-thirds of this investment with debt, as is common practice for such investments, the return on equity can rise to 20%. This observation leads us to the conclusion that a feed-in tariff, such as is already available in the wealthier Member States of the European Union, is sufficient to attract investment for the building and operation stage of a geothermal electricity-generating plant, if only the exploratory and drilling stages are completed.It, also, follows from the observation above that the cost of supporting our example geothermal plant need not be as high as we had calculated previously. Even if the public authorities chose to provide a 100% subsidy to the exploratory and the drilling stage, the cost would be 11 million €. For a long list of reasons a 100% subsidy is a bad idea. In practice, a ceiling of 75-80 % has been found to work much better 33. So the maximum subsidy that the public authorities should consider for the exploratory and drilling stages for our example geothermal project is 9 million €.


33 Workshop on Geological Risk Insurance, Der Geothermiekongress 2008, 11.-13. November 2008 in Karlsruhe http://geothermiekongress.org/index.html


A second observation is that drilling capacity is constrained. A realistic estimate is that a maximum of ten new drilling operations per year can be undertaken throughout the European Union in the next five years. This observation leads to a total financial envelope for geothermal energy amounting to 450 million € for a five-year programme of support.A third observation is that the exploratory stage will, in a number of cases, indicate that proceeding to the drilling stage is not necessary, thus saving further expense. Also, the drilling stage may be found to be unproductive before the entire budgeted expenses have been made. The data available from existing geothermal projects are not sufficient to provide a credible estimate of the probabilities of success or failure in the exploratory and the drilling stage. If one is willing to assume that the probability of success in the exploratory stage is uniformly distributed in the interval (0, 1) and that the probability of success in the drilling stage is uniformly distributed in the interval (probability of success in the exploratory stage, 1), then the expected cost of the subsidy per project is as low as 2 million €. On this (admittedly strong) assumption, a total financial envelope of public support of 450 million € (both from EU and Member State origin) would be sufficient to launch around 200 geothermal projects over five years.

2.4.6 Extension to the heat-generation optionThe analysis, so far has been illustrated by means of a geothermal plant producing electricity only. What about the case where that plant would only produce heat or produce jointly electricity and heat? The detailed analysis is given in the next chapter: “2.7 Generation costs of heat using geothermal energy”. A brief overview will be given here to complete the analytical arguments developed so far. The option to produce heat does not change the basic arguments calling for substantial support from public financing sources to speed up investment in geothermal energy.Heat generated by geothermal plants can be fed into local district-heating networks or into industrial processes that require mild heat. Energy in heat form does not travel well, so the prices that it can command cannot be very high. Besides, domestic heat is not needed in constant amounts throughout the year, so investments in it take longer to pay back. As is shown in the next chapter, the capital costs and the environmental benefits from generating heat from geothermal energy are about one fourth of the corresponding costs and environmental benefits from generating electricity from geothermal energy. A high-energy geothermal resource that can be used for electricity generation delivers more energy and environmental benefits than a resource that cannot be used for electricity generation. A programme of geothermal development, committing a fixed amount of funds and risk-tolerance, may discover any proportion of electricity-capable geothermal resources. The higher that proportion, the higher the financial and environmental returns of the programme will be, sometimes very significantly higher.Of course, this extra growth comes at a price. Electricity-generating geothermal plants are significantly larger and more expensive, on average, than heat-generating geothermal plants. Even more important, the risks in building and operating them over a number of business cycles are correspondingly larger.So, investments in heat generation alone cannot deliver a strong growth thrust to the geothermal energy sector. This is the one piece of bad news about them. Even so, they have several advantages, such as:

a. Local payback in exchange for public-opinion support for deep drillingb. They complement existing district-heating networks offering an alternative to other fuelsc. They can be combined with smaller binary cycle (if economics allow) electricity-generating plants to bring up the

utilisation of the reservoir to a maximum.d. Partial recovery of costs for failed high-energy drillingse. May be a useful complement to regional and local economic development programmes with positive effect on

employment and the viability of public infrastructure.f. They raise public awareness to the benefits of geothermal energy to a broader section of the public that focused large-

scale electricity plantsIn rough figures, the heat component of geothermal energy investment might be expected to generate between one fourth and one third of the overall utilisable energy from new investment in geothermal projects. In the opinion of the authors of the present study, based on the consensus of expert opinion, investment in heat need not be granted extra support, but neither must it be excluded from a geothermal energy support programme from public sources. Focusing exclusively on large-scale efficient projects has proven to be a risky strategy. Hedging by means of more numerous, if less efficient, plants is often more expedient and can, even, be economically efficient, if the current economic climate of high public indebtedness and low economic growth persists in the medium term. Of course, disbursing that much money to so many projects, whether for electricity generation or heat generation, will require a proper administrative and control mechanism. Such a mechanism is presented in the sequel of the present document. To complete this analysis, one must consider two further classes of barriers to the development of geothermal energy. They have already been mentioned at the start of this chapter. They are addressed below.



2.5 Varied legal and policy environment in EU Member States

For maximum impact, a programme of support that will encompass geothermal energy throughout the EU, it should operate in as uniform a legal and policy environment as possible. As has been amply documented in GEOFAR Report “Non-technical barriers and the respective situation of the geothermal energy sector in selected countries”, the feed-in tariff varies greatly from one Member State to another. A most important factor in this variation is the budgetary condition in each Member State. The feed-in tariff is the most readily observable parameter of the policy environment and the easiest to fix, if not by EU-wide regulation, at least by emulation. Fixing other important parameters is harder, because responsibility for them is often vested in local bodies with little or no contact with the EU. It is unrealistic to expect quick results in this area, so long as geothermal energy is not a significant part of the energy balance sheet. As in so many areas in which the EU has taken the lead, it is best to push the preferred policy in the limited areas where it can have a maximum impact and expect the tangible results to generate pressure for adaptation in other areas.

2.6 Awareness issues

It is no secret that renewable sources of energy have raised some controversy, sometimes deriving from the very environmental sensitivities that led to their adoption in the first place. In most cases, those controversies concern local issues. The question is: should public resources at EU level be devoted to those controversies? The answer is, of course, no. Yet, emulation is a powerful instrument for innovation, so some resources invested in awareness is necessary to make this instrument operational. Experience with other forms of renewable energy has shown that a small investment in this area is sufficient to generate huge free publicity and interest. A budget to maintain a high-quality central information depository for geothermal energy at EU level is, also, proposed in another stage (Further Dissemination Activities) of the GEOFAR project.

2.7 Generation costs of heat using geothermal energy

This section deals with the structure of heat generation costs when using geothermal energy. Due to the immense variation of conditions for each geothermal energy project it is impossible to have a basic calculation for all geothermal energy projects generating heat. Nevertheless, the following pages shall demonstrate how such a project could be calculated and which parameter is the most important for the realization of such a project. This will be done by first defining the basic conditions affecting the heat generation costs and second by calculating a sample project in order to show economic viability.

2.7.1 Factors determining heat generation costsThe main parameters for each geothermal energy project are the following:

1. Geological setup 2. Economic setup3. Setup of the demand side

Although, at first glance, there are only a few parameters determining the heat generation costs it is still not possible to assess the profitability of a geothermal energy project, as for each project the demand structure, the geological structure, the costs of capital and the existing geological data differ:

- Demand structure differs- Geological structure differs- Costs of capital differ- Geological data differs

Nevertheless, the structure of heat generation costs will be calculated by integrating basic assumptions and setting standard parameters for a standard project. Figure 2-12 illustrates (simplified) which factors are determining the costs for the generation of heat in a geothermal energy project. The figure shows that the setup of the demand side plays a very important role in determining the investments such as the drilling of boreholes, the size of the water pump, installation of buildings, the installation of a district heating network and the installation of a power plant’s components such as the ORC-cycle or a turbine. The divisor for any heat generation costs calculation depends critically on the “useable” heat of the geothermal energy resource.



Figure 2-12 Factors determining heat generation costs34

As every location has different conditions concerning its demand side which has to be examined in a pre-feasibility study it is not possible to consider these factors in a basic heat generation cost calculation. Thus, it will be assumed that all the heat and power generated will be delivered to the customers.Moreover, many costs are equal to those of a conventional heat generation installation. Therefore, the costs for a district heating network and special installations will not be included in the calculation. In addition, having in mind that every country disposes of individual laws the additional costs for taxes and fees, these will also be excluded. Thus, the calculation will take into consideration the following cost pools:

- Costs of capital (investments for drilling, water pump, substation)- Costs of depreciation (can also be considered as costs of capital)- Costs of operation (electricity)- Costs for maintenance

In addition to these costs, in cases of geothermal plants not connected to broader heat or electricity of other energy networks, a gas-fired or coal-fired power plant has to be connected to the geothermal plant in order to be able to cope with peak loads. The costs for this power plant are not included in the calculation as it has to be built both in the case of a geothermal plant and in the case of a gas-fired thermal power station.

For the calculation the following assumptions were made:- Assuming that the geothermal energy provides the base load energy for the district heating, all of the generated heat

will be delivered to the district heating network and therefore, the total hours of the plant will be 8.000 (hours/year)- No revenues will be calculated as the focus is only on the heat generation costs- The period under consideration is 30 years of operation- The loan will be amortized within 30 years- The depreciation time of the drilling is 50 years- The depreciation time of the substation is 30 years- The depreciation time of the pump is 3 years- The interest rate will be 7.5%


34 According to the Scientific Technical Report by Straubel, Ehrlich, Huenges, Wolff (1998). See also http://edoc.gfz-potsdam.de/gfz/get/5894/0/c5a4b8d3bd4953891227490978ee5e0c/9809-4.pdf


Assuming that the plant will generate a total of 8,000 hours per year is not unrealistic. Figure 2-13 exemplifies the possible annual load duration curve of a geothermal energy project. This curve can be found at several geothermal energy projects as these projects are supported by a heat load boiler which is started in rare occasions during a high peak load period.

Figure 2-13 Annual load duration curve

2.7.2 Calculation of heat generation costs of geothermal energy

For this position paper three basic sample projects were calculated and analyzed. The installed capacities of the sample projects are:

- Scenario 1: 10 MWth



Figure 2-14 shows the heat generation costs of each project. The figure illustrates that these generation costs are stable for the next 30 years. Moreover, the generation costs are decreasing over time a trend that is the exact opposite of the forecasted prices for fossil fuels. This is because of the lower costs for the loan which are falling over time. These already low costs are further reduced in net terms because they, also, generate revenues from the issuing of CO2 emissions certificates. Due to the assumption of generating and delivering 8.000 hours of heat per year the heat generation costs are lower than in other cases.

Figure 2-14 Heat generation costs of sample projects




The higher costs of scenarios 2 and 3 derive from the high depreciation costs due to the higher drilling costs as the investment sum for the drilling of boreholes. Larger scale plants can afford to drill somewhat deeper, although generally drilling costs increase exponentially with depth.Figure 2-15, illustrates the shares of each cost pool (interest, depreciation, maintenance and operation). One can observe that the costs for interest are very high and make up to 35% of the whole heat generation costs. Especially the 20 MWth project, which has the highest interest costs, shows the highest share of borrowing costs. At the same time, the biggest project has the smallest share of operating and maintenance costs. These facts point out the possible cost reductions due to economies of scale of geothermal projects. (Economies of scope in the form of co-generated electricity are also possible in large-scale heat generating plants, although they are not being taken into account in the present calculation). Therefore, reducing the financing costs of geothermal energy projects is the main variable to control so as to reduce heat generation costs.Looking at the allocation of heat generation costs for a 10 MWth geothermal power plant, the biggest share of the heat generation costs derive from the operating costs for the electricity to feed the water pump. But also the costs for the interest of the loan and for depreciation play a major role in the cost setup of this scenario.When looking at scenario 2 a slightly more equal distribution of the costs for electricity (operating), for depreciation and interest can be observed. Already in this scenario the interest costs account for the highest share, due to the large capital investment expenditure and to the debt required to finance it. Please note that scenario 2 with an installed capacity of 15 MWth will be used later on in this section for a sensitivity analysis.

Figure 2-15 Structure of heat generation costs from geothermal energyas per plant capacity

The proportion of the heat generation costs due to the very high drilling costs, nearly one third of the total heat generation costs for a geothermal energy project of 20 MWth derive from interest charges. In contrast to the heat generation by fossil fuels, the highest proportion of geothermal heat energy costs is made up the by the costs of financing such a project. In order to examine the leverage effect of the financing conditions of heat generation costs, a sensitivity analysis on interest rates will be conducted by looking at scenario 2. The interest rates for the loans used in the analysis are: 5%, 7,5% and 10%. Figure 2-16 shows the sensitivity of the sample project with capacity of 15 MWth.


35 The following figures derive from the Federal Department for Trade and Industry of Austria. See also http://www.bmwfj.gv.at/Ener-gieUndBergbau/Energiepreise/Seiten/default.aspx 31


Figure 2-16 Structure of heat generation costs from geothermal energySensitivity to interest rate

This figure illustrates the heavy influence of financing costs on the viability of a geothermal energy project. The GEOFAR Report “Non-technical barriers and the respective situation of the geothermal energy sector in selected countries” also suggests that for those projects one of the major problems is the lack of financial support by financing banks as the banks will charge higher interest rates due to the high risks in the early stages of geothermal energy projects. As soon as interest rates reach a certain level, it is no longer profitable to carry out a project. In some cases, a project developer will even not be able to find any financing banks and thus the project will not be carried out. The difference in the heat generation costs between the calculations at an interest rate of 5% to one with 10% can be as high as 30%.This results in the need of financial support from public sources for geothermal energy projects in the early project phases due to the high risk effect.

2.7.3 Comparison of the heat generation costs Fossil-fuels versus Geothermal Deriving an average cost of generating heat from fossil fuels in Europe is not easy, because of the high proportion of the operating costs. Approximately 60% of the heat generation costs derive from the operating costs and thus, the price for fossil fuels is the main parameter of the heat generation costs. As the prices for fossil fuels are very different from country to country and the prices for fossil fuels are very volatile35 a meaningful assessment of heat generation costs is not possible.For example, in Italy, the prices of light fuel are 120% higher than those in Luxembourg which is due to the high taxes for light fuel in Italy. In the case of gas prices, the gap between the highest priced country, i.e. Denmark, and the country with the lowest prices, i.e. Romania, is about 215%.Due to the high differences in the costs for fossil fuels in each EU country a comparison of the heat generation costs is nearly impossible. Nevertheless, Fraunhofer Institute for Environmental, Safety and Energy Technology carried out a study for Germany comparing the heat generation costs between fossil fuels and geothermal heat plants delivering heat to district heating networks. In that study, the correlation of heat generation costs with the increase in prices of fossil fuels is monitored and compared to that of geothermal energy. Operating costs for both geothermal and fossil-fuel heat-generating plants ultimately depend on the price of primary energy. But the primary energy of geothermal plants is not entirely dependent on fossil fuels, while that of fossil-fuel plant is.


Thus, in the case of ever-increasing fossil fuel prices, fossil-fuel plants will see their operating costs rising much more rapidly than the costs of geothermal plants.Figure 2-17 illustrates the results of the study and it clearly highlights the advantages of geothermal energy when assuming an increase in prices for fossil fuels compared to the fuel prices in 2006. The heat generation costs of geothermal energy are low in absolute terms due to the assumption of a high rate of utilisation of geothermal energy, e.g. up to 8,760 hours per year.36 This cost advantage in absolute terms is not based solely on the technical suitability of geothermal energy, but, also, on its economic characteristics, that is on its low variable costs and its high fixed costs.

The cost advantage in absolute terms is additional to the relative cost advantage of geothermal power, in case primary energy prices rise rapidly. Figure 2-17 Heat Generation Costs Comparison 37

2.8 Conclusions

The main obstacle of geothermal energy is neither the overall long-term profitability nor the technical feasibility of geothermal energy projects, but the lack of financial support in the critical early project stages. This lack of financial support is caused by the high geological risks of not finding the assumed geothermal potential in the quantity or quality needed.Geothermal energy holds great promise for generating electrical power. In comparison to other renewable energy sources, geothermal energy (along with hydroelectric power) holds an advantage in base load capacity. Given that the hydroelectric power potential in Europe is wholly utilised, geothermal power is the only available base-load-capable renewable form of energy. Thus, it should be part of a well-diversified renewable energy portfolio. The experience of the energy sector in the last forty years has shown that active intervention by the public authorities is required, both in the form of regulation and in the form of direct and indirect financial support to remedy market failure and, thus, to build an energy portfolio that meets, besides market efficiency, social efficiency goals, such as energy security and the protection of the environment.Analysis on the heat generation option for geothermal energy has demonstrated that geothermal energy is a highly reliable clean source of energy that can be seriously considered as an alternative to fossil fuels for generating heat. There is significant potential for geothermal heat production for district heating networks in Europe. Geothermal energy, where it can be made available, can replace heat generation by fossil fuels, especially in Eastern Europe, where many district heating networks already exist. On the economic side, the high volatility of prices for fossil fuels and the forecast increase in on fossil fuel imports are the main arguments for shifting heat (and power) production towards renewable energy sources, as far as this is possible. It has been shown though that the viability of heat generating geothermal energy projects is critically dependent on receiving an appropriate and properly targeted level of financial support from public sources. Power and heat generation from geothermal energy are complementary activities. A high-energy geothermal resource than can be used for electricity generation delivers more energy and environmental benefits than a resource that cannot be used for electricity generation. A programme of geothermal development, committing a fixed amount of funds and risk-tolerance, may discover any proportion of electricity-capable geothermal resources. The higher that proportion, the higher the financial and environmental returns of the programme will be, sometimes very significantly higher. Thus, electricity generation should, in principle, receive a higher priority in receiving financial support from public sources. However, the analysis in this working document has shown, that the present relatively slow rate of investment in geothermal energy and a host of other considerations call for non-discriminating between electricity generation and heat generation. There is no evidence to warrant setting specific targets for each of those two uses of geothermal resources. Providing equal terms of


36 In section “2.4.3 Calculation of heat generation costs of geothermal energy” a usage of 8,000 hours per year was assumed.37 Jentsch, Pohlig, Dötsch (2008): Leitungsgebundene Wärmeversorgung im ländlichen Raum, Handbuch zur Entscheidungsun-

terstützung - Fernwärme in der Fläche, Fraunhofer Institut für Umwelt-, Sicherheits- und Energietechnik, p. 21.See http://publica.fraunhofer.de/dokumente/N-113625.html


Thus, in the case of ever-increasing fossil fuel prices, fossil-fuel plants will see their operating costs rising much more rapidly than the costs of geothermal plants.Figure 2-17 illustrates the results of the study and it clearly highlights the advantages of geothermal energy when assuming an increase in prices for fossil fuels compared to the fuel prices in 2006. The heat generation costs of geothermal energy are low in absolute terms due to the assumption of a high rate of utilisation of geothermal energy, e.g. up to 8,760 hours per year.36 This cost advantage in absolute terms is not based solely on the technical suitability of geothermal energy, but, also, on its economic characteristics, that is on its low variable costs and its high fixed costs.

The cost advantage in absolute terms is additional to the relative cost advantage of geothermal power, in case primary energy prices rise rapidly. Figure 2-17 Heat Generation Costs Comparison 37

2.8 Conclusions

The main obstacle of geothermal energy is neither the overall long-term profitability nor the technical feasibility of geothermal energy projects, but the lack of financial support in the critical early project stages. This lack of financial support is caused by the high geological risks of not finding the assumed geothermal potential in the quantity or quality needed.Geothermal energy holds great promise for generating electrical power. In comparison to other renewable energy sources, geothermal energy (along with hydroelectric power) holds an advantage in base load capacity. Given that the hydroelectric power potential in Europe is wholly utilised, geothermal power is the only available base-load-capable renewable form of energy. Thus, it should be part of a well-diversified renewable energy portfolio. The experience of the energy sector in the last forty years has shown that active intervention by the public authorities is required, both in the form of regulation and in the form of direct and indirect financial support to remedy market failure and, thus, to build an energy portfolio that meets, besides market efficiency, social efficiency goals, such as energy security and the protection of the environment.Analysis on the heat generation option for geothermal energy has demonstrated that geothermal energy is a highly reliable clean source of energy that can be seriously considered as an alternative to fossil fuels for generating heat. There is significant potential for geothermal heat production for district heating networks in Europe. Geothermal energy, where it can be made available, can replace heat generation by fossil fuels, especially in Eastern Europe, where many district heating networks already exist. On the economic side, the high volatility of prices for fossil fuels and the forecast increase in on fossil fuel imports are the main arguments for shifting heat (and power) production towards renewable energy sources, as far as this is possible. It has been shown though that the viability of heat generating geothermal energy projects is critically dependent on receiving an appropriate and properly targeted level of financial support from public sources. Power and heat generation from geothermal energy are complementary activities. A high-energy geothermal resource than can be used for electricity generation delivers more energy and environmental benefits than a resource that cannot be used for electricity generation. A programme of geothermal development, committing a fixed amount of funds and risk-tolerance, may discover any proportion of electricity-capable geothermal resources. The higher that proportion, the higher the financial and environmental returns of the programme will be, sometimes very significantly higher. Thus, electricity generation should, in principle, receive a higher priority in receiving financial support from public sources. However, the analysis in this working document has shown, that the present relatively slow rate of investment in geothermal energy and a host of other considerations call for non-discriminating between electricity generation and heat generation. There is no evidence to warrant setting specific targets for each of those two uses of geothermal resources. Providing equal terms of

amount to no more than 450 million € to be committed over a period of five to seven years. Support should targetthe early stages of geothermal energy projects, namely the exploratory stage and the production-drilling stage. Aftersuch support enables discovery of the geothermal resource, feed-in tariffs in the range of 90-100 €/MWhel earn privateinvestors operating in normal financial market conditions a more than adequate rate of return on capital invested. Underthe recommended financial support scheme, each 1 euro spent by public authorities may be expected to attract additionalprivate investment in geothermal energy amounting to between 2 and 2,5 €. In the sequel of this document GEOFARproposes a mechanism to deliver that support efficiently to the geothermal energy industry.



3. A Geothermal Risk Mitigation (GeoRiMi) programme

3.1 Principles of operation

a. Support for geothermal investment focuses on the exploratory stage and the drilling stage.b. Private investors must provide a significant part of the total investment in both the exploratory and the drilling stage by committing equity capital.c. Publicly-funded support to be limited in time and total amount.d. Publicly-funded support is provided to cover exploration and resource-discovery risk only.e. For all other purposes publicly-funded support uses the normal business-financing conduits.f. Regional and local public authorities must be supported in their efforts to understand and develop geothermal resources in their jurisdiction.

3.2 Reasoning

a. After the successful conclusion of the exploratory and the production-drilling stages, feed-in tariffs in the range currently offered in the more prosperous and environmentally aware EU Member States (adjusted for inflation) for electricity-generation from geothermal projects are sufficient for private-sector financing of the subsequent stage of building a generating station and, then, operating it. Heat-generation projects face the same kind of early-stage risks, but the potential returns, both private and public are significantly lower. GEOFAR has shown that there exists significant potential for profitable sale of heat-energy, once the risks of exploration and production-drilling have been met. Thus, support should be offered to heat-generation projects on equal terms as to electricity-generation plants. That is the operator should demonstrate that, once the exploratory and production-drilling stages are successfully over, the project should stand without further public support, except through feed-in tariffs.

b. Private operators have an informational advantage over public authorities, since they have chosen to specialise in geothermal resources development. Thus, a significant own-contribution aligns their interests with the interests of the public authorities and reduces the scope of opportunistic behaviour (moral hazard).

c. Since the goal of the public authorities is immediate investment, the time frame of support must be limited in time. Although some drilling projects may last for up to three years, support must be made available for a period of five to seven years. Moreover, a ceiling for the total of public support must be adopted to encourage operators that can start early and to respect the public authority’s budget discipline.

d. Public support is to be used solely to pay costs associated with exploratory and drilling operations that fail to recover exploitable geothermal resources. Successful operations can pay their own way.

e. Existing conduits for business-financing, that is banks, will be used to streamline the administering of the support scheme. Thus, most of the supervision difficulties and monitoring costs associated with channelling public support to private geothermal operators will be minimised through the intermediation of specialised intermediaries, that is, of the banks.

f. The development of geothermal resources requires specialised knowledge that public authorities at the local and regional level cannot afford. This is especially true with local government in many Eastern European EU Member States. Public decision-makers should be given affordable access to specialised advice about the geothermal potential of the areas under their jurisdiction. This end can be achieved by partially financing pre-feasibility studies that are commissioned by local governments seeking to ascertain and develop the geothermal potential in their communities.

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The table below attempts a side-by side comparison of two support alternatives that could be deployed EU-wide and deliver results in the medium-term. One should note that, in practice, feed-in tariffs are set by EU Member-States. Widely divergent feed-in tariffs in some EU Member-States would, of course, distort the comparison and, more significantly, the entire EU single market in energy.

Guarantees mechanism Increase in feed-in tariffTargeted, focused on perceived market deficiency Broad focusedHelps new entrants Good for established, large, well diversified operatorsHelps independent operators Promotes consolidation, risk-poolingNeeds active management at EU level Only needs supervision at EU levelEU pays support Consumers pay supportTime profile: medium term Time profile: long termCost profile: close-ended Cost profile: partially open-endedHelps financially weaker and economically poorer

EU Member StatesAdvantages financially stronger and economically richer EU

Member StatesA new approach to geothermal energy Not very effective for geothermal energy so far

3.3 Operation of the geothermal guarantees mechanism

Step 1. The Geothermal Risk Mitigation Programme invites suitably qualified financial institutions to participate in its geothermal guarantees program.Step 2. Geothermal project promoters and investors approach qualified financial institutions. Geothermal project promoters and investors agree to provide equity of 40% or more38 towards the cost of conducting exploratory geothermal analyses. The remainder will be provided by the financial institution in the form of a loan carrying market rates of interest.Step 3. If the exploratory results are discouraging, the project is abandoned. The financial institution receives from the public authority the amount it committed to the project. The project operators and investors have a right of first refusal on the residual equity that will end up being held by the Geothermal Risk Mitigation Programme.Step 4. If the exploratory results are encouraging, the project operators and investors must provide additional equity of one third or more39 of the projected total drilling cost. The remainder will be provided by the financial institution in the form of a loan carrying market rates of interest. Step 5. If the drilling stage fails to find adequate thermal resources, it is abandoned. The financial institution receives from the public authority the amount it committed to the project. The project operators and investors have a right of first refusal on the residual equity that will end up being held by the Geothermal Risk Mitigation Programme.Step 6. If the drilling stage is successful, the project is released to the building stage and receives no further support from the Geothermal Risk Mitigation Programme mechanism. Debt financing of the building stage together with the debt accumulated in the earlier stages will, following current practice for similar long-lived projects, be consolidated by the financial institution into a long-term loan to be serviced over the productive lifetime of the project.The Geothermal Risk Mitigation Programme mechanism runs for a maximum of five or seven years. If the total public financial support envelope ends up being used earlier than the term of five or seven years, the mechanism is, also, wound down at that time.The object of the guarantees to be extended by the Geothermal Risk Mitigation Programme are solely the costs actually incurred by the project operators in either the exploratory or the drilling stage of a supported geothermal project. No guarantee covers any profits foregone by the project operator.The Geothermal Risk Mitigation Programme should ensure that its operations are balanced in terms of geography, that is that they extend to all EU Member States with geothermal potential, in terms of project stage of development (pre-feasibility, feasibility, early exploration, exploration, drilling) and in terms of project production orientation (electricity or heat).

38 Member States may choose to commit part of the equity in selected geothermal projects in the form of grants or other publicly-funded support. This may be allowed under the GEOFAR proposals, provided that the residual claim of such support on the project funds inflows is junior to the GeoRiMi claims and the support is not at a level that effectively dilutes the interest of the project devel-oper in promoting a viable project.

39 Same as above.

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3.3.1 Decision-making and management structure of the geothermal guarantees mechanismOur proposal is that the Geothermal Risk Mitigation Programme be incorporated as a multilateral financial institution. The only goal of the programme should be to attract suitably qualified geothermal projects and to extend guarantees against resource-discovery-risk to suitably qualified geothermal projects.The proposal rests on two findings:First, the expected number of suitably qualified projects throughout the European Union is small, so effective pooling

of risks and administrative costs can only be done at the European Union level.Second, the nature of the risks to be assumed by the programme is so specialised that they cannot be effectively

mitigated except by an equally specialised public policy instrument.The proposed Geothermal Risk Mitigation Programme should be authorised to extend guarantees amounting to a maximum of ten times the amount of its authorised capital. This is in line with practices in national guarantee funds run by EU Member States. Since the entire foreseen support envelope cannot exceed 450 million €, the proposed authorised share capital of the Programme is 45 million €. It may be paid in at the rate at which guarantees are extended. If, in the course of its operation, the equity of the Programme falls below 30% of the paid-in capital, the Programme is to be wound down.The shareholding structure of the Programme should be as follows: 60% European Commission30% European Investment Bank10% open to financial institutions

This structure is modelled on the holding structure of the European Investment Fund, with the proportions altered to reflect the emphasis in publicly-funded support.The operation of the Programme should be overseen by a Board of Directors nominated by the European Commission, the European Investment Bank and the financial institutions that hold shares in the Programme. The Board of Directors sets its rules of operation in accordance with best practice in multilateral financial institutions. It selects and appoints the senior management of the Programme.The Programme must have access to a specialised pool of geological and engineering advice. The geological surveys and professional associations of mining engineers in all EU Member Sates will be asked to nominate one geologist and one mining-engineer (and one alternate for each of them) to constitute the pool of advisors to the Programme. The advisors would be required to be independent of the projects they will be called on to advise. The prevailing consensus is that practicing geologists and mining-engineers get significantly better in their judgement with time. Therefore, the Programme should insist on receiving nominations of the most senior and experienced geologists and engineers to its pool of advisors. For each project to be assessed for support, the senior management of the Programme will be required to select three geologists and three engineers to advise it on the geological and engineering aspects of the project. In particular, the advisors will be required to approve the scope of each proposed project and define in advance the technical parameters defining project success, partial success or failure, as well as for setting out conditions for early abandonment on technical and cost considerations.The selection of projects to be supported will be the responsibility of the senior management of the Programme, suitably advised on the geological and engineering aspects of the projects. No quantitative targets need be set for the proportion of projects to be supported at the exploratory stage or the production-drilling stage. Nor should quantitative targets need be set for the proportion of projects to be supported in electricity generation or heat generation. Senior management must, however, ensure a proper balancing of risk along those two dimensions as well as in terms of geography. Beyond pooling the risks, senior management must, also, strive to maximise the environmental benefits of the Programme.Project developers may apply for support either prior to starting the exploratory stage or prior to starting the production-drilling stage. Selection of projects for support at the exploratory stage does not necessarily imply selection of the continuation of that project at the production-drilling stage.

3.3.2 Revenues and expenses of the Geothermal Risk Mitigation ProgrammeThe programme should charge guarantee fees proportional to the amount of drilling cost it guarantees at any one time. The senior management of the Programme should have discretion to set the rate of guarantee fees. In our view, those rates should be, on average, 6%, lower that the rates charged in the very few projects that have managed to obtain insurance coverage, but higher than the self-insurance rate used for investment planning in large, well-diversified private companies operating in the energy and natural-resources sectors.

GeoRiMi PROJECT46


This fee should be paid in advance and should be refunded pro-rata in the event of the guarantee being called for an amount lower than contracted. For example, if a project supported at the production-drilling stage is found to be a failure before its full costs are incurred, the guarantee will only cover two-thirds at the maximum of the costs incurred (and documented as incurred). In that case, a part of the guarantee fee proportional to the “unused” guarantee will be refunded.A second source of funds for the Programme, apart from guarantee fees, would be the proceeds from disposal of residual equity in failed or partially successful projects that the developer may choose to abandon for any reason. Such equity must be disposed of in the matter judged most advantageous for the Programme by the senior management.A third source of funds for the Programme is here offered as an option. It could consist of a success fee to be paid by the developer in production-drilling stage as soon as the production-drilling stage is successfully completed and the project can graduate into the normal business financing conduit.In our estimate the costs of administering the Programme, including the fees for paying such geological and engineering advisors as will be called upon to advise, should not exceed the revenue from guarantee fees. A separate account should cover the cost of the proposed partial financing of pre-feasibility studies that are commissioned by local governments seeking to ascertain and develop the geothermal potential in their communities. The expected cost of this programme, as envisaged in our proposal should be more than met from the revenues from disposals of residual equity.

3.3.3 Aligning interests in the Geothermal Risk Mitigation ProgrammeThe Geothermal Risk Mitigation Programme is proposed as the nexus where the interests of three classes of principals meet:The geothermal projects developersThe banksThe public authorities

Geothermal project developers get affordable risk coverage. Without the Programme such coverage is either unavailable or unaffordable. They have little incentive to take extreme risks since they commit much of their own capital and, besides, they submit themselves to the terms of the exploratory or production-drilling guarantee agreement they must negotiate with the Programme to get this coverage. Moreover, they should pay guarantee fees and, possibly, a success fee.The banks get an opportunity to expand their business in a relatively unknown field for them, but with the major risk covered by the public authorities. Admittedly, only a few banks may choose to commit the management time administrative resources to enter a new business sector. The size of the Programme is such that one bank per Member State in which projects are expected is enough.The public authorities take the major risk of supporting a business sector that the market has not selected for development. In return, they get an addition with base load capacity and very small CO2 footprint to their portfolio of renewable energy sources. One should note that unlike the feed-in tariff, the GeoRiMi Programme calls for financing from taxes (instead of from consumers in their energy bills) and for the commitment of management attention on the part of the public authorities (instead of the feed-in tariff that need minimal monitoring).There exists one point of potential conflict of interest that has received much attention from both developers and experts in the course. It concerns the geological information that even a failed project generates. Even if the developer of the failed project walks away, he or she has access to the geological information that the project generated. The party that would be prepared to pay the most for that information would be the concession holders in neighbouring areas. As a residual equity holder, the programme should be entitled to the proceeds from selling that information to the highest bidder. However, it cannot prevent the information finding its way through other conduits to the parties most interested in it. Therefore, the Programme should commit itself to publish the geological information generated by the projects it supports and make it accessible to interested parties for a fee that will enable it to recover its costs of publishing the data. The information should be available to interested parties only after the supported project finishes, either in success or in failure.

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3.4 Summary of financial flows

Here is a possible baseline scenario for the operation of the Geothermal Risk Mitigation Programme.

Programme Post-Programme

Total Present Value discounted

at 5%Projects started Year 1 Year 2 Year 3 Year 4 Year 5 Year

exploratory 13 16 20 23 26 98 drilling 5 7 10 12 14 48

Flows of funds (million €)Total investment 63,0 86,0 120,0 143,0 166,0 578,0 489,4Public support 27,5 37,5 52,4 62,4 72,4 252,2 203,4Equity-sourced 21,9 29,7 41,3 49,2 57,0 199,1 168,6 Debt-sourced

(market)41,2 28,8 41,2 41,5 46,6 -72,4 126,9 117,4

Additional market

sourced investment

11,1 26,6 48,8 64,3 168,5 319,3 245,0

total investment 897,3 734,4Public support/total investment 28,1% 27,7%

Table 3-1 Time-profile of the operation of the Geothermal Risk Mitigation Programme

The time-profile above has been calculated on the following assumptions:Average cost of exploratory stage of each project: 1million €Average cost of production-drilling stage of each project: 10 million €

for one geothermal doublet (two wells)Success rate at exploratory stage: 25%Success rate at production-drilling stage: 35%Time frame of exploratory stage of project: 6 monthsTime frame of production-drilling stage of project: 6 months[Commitment of equity schedule for generating station: one third in each of year 1, year 2 and year 3.]

A detailed description of the financial model developed by GEOFAR to evaluate the features of the proposed support mechanism is given in section “8 Projected GeoRiMi Financial flows” below.As can be seen in the graph below (Figure 3-1), the financing of a large number of investment projects in the exploratory and production-drilling stage is effected roughly equally from private and public sources with the balance being carried over to longer-term projects through the financial intermediation system.

GeoRiMi PROJECT48


Figure 3-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory and drilling

This rough balance is somewhat changed if the rate of success in drilling projects varies significantly, as shown in the table below (Table 3-2):

Production-Drilling Stage Success Rate

Total Investment

Public Support

Equity-Sourced

Debt Carried Over

Additional Market-sourced

Investment

public support/total investment

[Present Value discounted at 5% in million €]35% 734,4 203,4 168,6 117,4 245,0 27,7%30% 699,4 216,3 168,6 104,6 210,0 30,9%25% 664,4 229,2 168,6 91,7 175,0 34,5%20% 629,4 242,1 168,6 78,8 140,0 38,5%15% 594,4 254,9 168,6 65,9 105,0 42,9%10% 559,4 267,8 168,6 53,0 70,0 47,9%

Table 3-2 Effects of success rate on funding flows

The one-but-rightmost column of Table 3-2 shows the additional investment in electricity generation [or heat generation] that one can expect as a result of the Geothermal Risk Mitigation Programme. As already stated, this is expected to be financed from market sources of funds without additional public support, beyond the feed-in tariff.So, on the basis of this baseline scenario, one can expect over the lifetime of the programme that public support amounting to between 200 and 270 million € (in present value terms) can mobilise private investment amounting to roughly 400 million € (also in present value terms).

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40 For a list of reasons, please see: http://geothermiekongress.org/geofund_Robertson-Tait1.pdfterstützung - Fernwärme in der Fläche, Fraunhofer Institut für Umwelt-, Sicherheits- und Energietechnik, p. 21.See http://publica.fraunhofer.de/dokumente/N-113625.html

GeoRiMi PROJECT50

Figure 3-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds – exploratory and drilling

3.5 Insurability

The analysis carried out in WP2 (see report “Non-technical barriers and the respective situation of the geothermal energy sector in selected countries”) and WP3 of the GEOFAR project has shown that resource-discovery risk is the most important barrier to development of geothermal energy in the medium term. It is normal to look at the insurance industry to see if it could provide coverage against that risk.Is resource-discovery risk insurable40? This question has exercised us from the very beginning. The theory and all the academic evidence show that mining risk is generally not insurable. But there is precedent. As shown in section “1.3 Sample projects of deep geothermal energy”, there have been insurance companies that managed to draw up contracts acceptable to their shareholders and regulators that insured resource-discovery risk. In the majority of cases, however, insurance for resource-discovery risk is not available.Industry figures provided on condition of not mentioning their source suggest that the cost of self-insurance for large well-diversified private energy companies may be as low as 5% of the capital cost of production-drilling. Large specialised geothermal operators claim drilling failure rates as low as 5%. These figures have to be set against published figures citing the risks of dry holes in new geothermal fields as high as 50% and in already drilled geothermal fields as high as 10%.The balance of the evidence suggests that resource-discovery risk is not yet mature for insurance by privately owned insurance companies. Our proposal of a geological risk mitigation programme aims to provide exactly the geological risk coverage that is not generally available. However, the proposed fund will be funded from public sources. Thus, it is important to try to reduce its usage as much as possible by attracting private funds. One approach could be to offer to cover the entirety (100%) of geological insurance costs for qualified geothermal projects that choose to forgo coverage from the Geothermal Risk Mitigation Programme.


4.1 Awareness - Needs for Financial Support

Local and regional actors are crucial for the achievement of EU energy policy objectives. Sustainable energy and especially geothermal energy represent a significant investment potential to be mostly realized at local level, bringing benefits for local economies, improving quality of life of citizens and mitigating climate change. The question is: how can public investors be motivated to invest into geothermal power project development?Many local actors across whole Europe assume geothermal potential in their region and would like to contribute their part to climate protection with the idea of the utilization of geothermal energy as heat and possibly power supply in the surrounding local area. But they do not have the financial resources to have this potential assessed by professional engineering and geological companies. For this reason many geothermal fields are not exploited today even if they could offer heat supply to a large extent and potentially even power production on a small scale.GEOFAR Instrument I is established to eliminate this problem in the very early stage of geothermal projects. It is obvious that on the one hand not all areas where geothermal potential is assumed and for which plans of utilization exist will result in sufficient thermal capacity to realize a project. On the other hand, if the potential can be proven and the sub-surface demand structure provides the possibility for heat use, a geothermal project could contribute substantially to infrastructure and attractiveness in a particular community or region. Above all, regions in Eastern Europe, that still lack modernization of heat infrastructure could be favoured by the integration of geothermal energy in the future heat supply portfolio. Moreover central European countries have to achieve set CO2 reduction targets.Realising more projects means gaining more experience in practical utilization of geothermal plants and progress to technology development. Moreover, communities have to contribute to climate protection objectives, while they profit from price stability as geothermal energy is independent from price fluctuations of fossil fuels.The proposed Instrument I will serve to generate, at low cost, geothermal projects that can later be considered for support under Instruments II and III, where the cost is many times higher. A larger number of well prepared projects, especially from areas with high geothermal potential, is necessary if the resources to be committed under Instruments II and III are to be efficiently deployed. On the basis of experience with geothermal projects, so far, one should expect Instrument I to demonstrate to local and regional authorities the need to engage in public-private sector partnerships that can harness the technical and organisational capabilities of private enterprise to public service purposes. Such partnerships can only work, if they meet a rigid standard of transparency. Instrument I should mandate that such a standard is set at the very beginning of geothermal project planning. Instrument I studies should set rules and procedures according to best-practice standards that have been shown, from experience, to work. Those rules and procedures are the ones serving the twin goals of efficiency and transparency.

4.2 Description of Instrument I

4.2.1 Objectives of Instrument IThe support by Instrument I comprises financial subsidies in the very early phase of geothermal projects. With this assistance GEOFAR wants to create a new awareness of geothermal energy by giving the opportunity of creating first geothermal concepts to those decision makers who already have plans or at least consider geothermal energy as an alternative for conventional energy supply utilizing coal or gas. Equipped with this understanding of geothermal resources and the financial aid, decision makers of municipalities in particular and corresponding legal forms of public bodies, shall be encouraged to realize their plans concerning geothermal energy supply. Instrument I helps ideas become projects.Instrument I can show how workable solutions can be applied in practice. As a result of the offered subsidies, the heads of public institutions do not have to bear in full the high risks and costs in the beginning of a geothermal project phase on their own, but obtain a part of the “seed” capital which is necessary to explore and confirm the geothermal potential that was assumed. Learning effects are significant in geothermal technology. If the initial studies are successful in identifying realistic prospects for actual investments, one should expect them to mobilise interest in more studies, more technically advanced

4. Instrument I

INSTRUMENT 51


studies and, perhaps, even financing of some additional pre-feasibility studies done with no subsidy.Instrument I therefore should be a direct subsidy with an appropriate percentage at a maximum ratio of 90% (flexible downwards if there is strong demand) of eligible costs and a fixed upper limit amount of 25,000 € primarily for geo-technical investigations to be conducted by engineers and geologists. Only municipal and regional governments should be eligible for funding. In general, local and regional development subsidies can be combined with Instrument I funds. However the limits set by EU subsidy regulations must always be respected. Instrument I funding will cover in part costs for pre-feasibility studies which are the basis for a geothermal project concept. The financial assistance shall not be granted retrospectively for tasks or projects that have been performed in the past as the subsidy should serve as an incentive. The main objective is to support the communities in three aspects:

a. To bring an idea to a project conceptb. To ensure that supported studies meet defined quality standardsc. To open the possibilities for PPP (Private-Public-Partnership) projects for the further development phases

The interviews conducted mainly in Eastern Europe showed, that local communities have need support exactly along those lines. The idea of Instrument I arose by analyzing further subsidy programs in Germany, where the “Initiative for Climate Protection” has exactly the same aim to enable carbon-reduction projects on a communal level.

4.2.2 Target groupAssistance supported by the Instrument I is offered exclusively to a local or regional authority like municipalities or another public body or a grouping of public bodies from an EU member country. Public body means a body created by a public authority or a legal entity governed by private law with a public service mission, owned by more than 50% by public sources, whose internal procedures and accounts are subject to control by a public authority and for whose liabilities a public authority will accept responsibility, in the event that the public body ceases its activities. The size of the municipality or the corresponding legal organization must comprise at least 25,000 inhabitants, counted in the year of application. The number of inhabitants is important because it has to be ensured that there are enough end-consumers for a large project like a geothermal heat plant and that the community in general has a critical size to enable such an infrastructure project. In individual cases even a smaller commune can be authorized to obtain subsidies if it presents potential consumers, for example commercial industries, that use a respective amount of heat for their purposes, so that an economically meaningful utilization of the geothermal resource and the related infrastructure is possible.

4.2.3 Eligible costsEligible pre-feasibility studies should elaborate geothermal project concepts. Support has to be shown to be necessary for carrying out the project and the application of funds has to comply with the principles of sound financial management, in particular value for money and cost-effectiveness. The funds under Instrument I should be used for the advance preparation of feasibility studies, for the structuring of the project and for elaboration of business plans. No services provided by the public authority commissioning the study on own account will be supported.

INSTRUMENT52


Instrument II aims at proving financial support from public sources to operators undertaking exploratory work in preparation of a project utilising geothermal energy to generate electricity or heat.The support is in the form of a guarantee of 60% of the costs of exploratory studies undertaken to establish the existence of a geothermal resource, including geophysical studies, seismic studies and exploratory drillings. Project operators must demonstrate that they can provide 40% of the costs of exploratory studies in the form of equity. Project operators must, also, demonstrate that they have the support of a qualified financial institution that will provide the remaining 60% of the cost of exploratory studies in the form of a loan.The guarantee will be used exclusively to indemnify the financial institution in the event of a credit loss resulting from the exploratory studies not producing evidence of probable usable geothermal resources.The guarantee will be held in the books of the Geothermal Risk Mitigation Programme, a specialised financial institution to be established along the lines of the European Investment programme. Its authorised share capital will be one tenth of the guarantees it will be expected to extend, that is, 45 million €. This share capital will be paid in proportion to the growth of the commitments of the programme. The European Commission, through its Regional Policy funds, will be the principal shareholder with 60% of the shares. The European Investment Bank will hold 30% of the share capital while the remaining 10% will be open to subscription by banks and other financial institutions.The operation of the Geothermal Risk Mitigation Programme should adhere to the best-practice rules applicable to financial institutions and to multilateral financial institutions. As a specialised and narrow-focused financial institution it should have access the highest level geological and engineering expertise in the field of geothermal energy, so at to be able to set its own standards for the conditions for extending guarantees and paying indemnities in line with the latest geological and engineering practices.The residual equity from failed and indemnified exploratory studies, including the technical reports produced, is the property of the Geothermal Risk Mitigation Programme and can be disposed at the discretion of the programme.

Figure 5-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory only

5. Instrument II

INSTRUMENT 53


Figure 5-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds – exploratory only

INSTRUMENT54


Instrument III aims at proving financial support from public sources to operators undertaking production drilling following successful exploratory work in preparation of a project utilising geothermal energy to generate electricity or heat.The support is in the form of a guarantee of 67% of the costs of production-well-drilling for geothermal fluids. Project operators must demonstrate that they can provide 33% of the costs of production-drilling in the form of equity. Project operators must, also, demonstrate that they have the support of a qualified financial institution that will provide the remaining 67% of the costs of production-drilling in the form of a loan.The guarantee will be used exclusively to indemnify the financial institution in the event of a credit loss resulting from the production drilling not discovering usable geothermal resources.The guarantee will be held in the books of the Geothermal Risk Mitigation Programme, a specialised financial institution to be established along the lines of the European Investment programme. Its authorised share capital will be one tenth of the guarantees it will be expected to extend, that is, 45 million €. This share capital will be paid in proportion to the growth of the commitments of the programme. The European Commission, through its Regional Policy funds, will be the principal shareholder with 60% of the shares. The European Investment Bank will hold 30% of the share capital while the remaining 10% will be open to subscription by banks and other financial institutions.The operation of the Geothermal Risk Mitigation Programme should adhere to the best-practice rules applicable to financial institutions and to multilateral financial institutions. As a specialised and narrow-focused financial institution it should have access the highest level geological and engineering expertise in the field of geothermal energy, so at to be able to set its own standards for the conditions for extending guarantees and paying indemnities in line with the latest geological and engineering practices.The residual equity from failed and indemnified production-drillings, including the technical reports produced, is the property of the Geothermal Risk Mitigation Programme and can be disposed at the discretion of the programme.

Figure 6-1 Geothermal Risk Mitigation Programme Flows of investment funds – drilling only

6. Instrument III

INSTRUMENT 55


Figure 6-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds – drilling only

One should note that operations under the Geothermal Risk Mitigation Programme will be carried out subject to the provisions of standing laws governing property, land management, mining activity, natural-resources use, corporate governance, bankruptcy etc in each Member State. Obviously, the Programme will face a difference range of options, if it is called upon to dispose of any assets it ends up owning. These options should include relinquishing its residual interest, if the Programme finds holding on to them to be prejudicial to its overall interests.

ConclusionsTo accelerate investment in geothermal energy the EU should dedicate financial and administrative resources to support the origination and early stages of suitably qualified geothermal projects. This support should be limited to the medium-term in time and to a maximum of 450 million € over the lifetime of the support programme.Support for geothermal projects should be channelled through a specialised financial institution to be called the Geothermal Risk Mitigation Programme. The EU should set up this programme with financial and management participation by the European Investment bank and private sector financial intermediaries. The mission of this programme should be to provide guarantees solely against resource-discovery risk. All other risks in supported geothermal projects should be borne by project operators (which could be public utilities or private enterprises) and their sponsoring financial institutions. To carry out its mission the Programme should ensure access to a pool of geology and mining-engineering experts, the members of which will be nominated by geological surveys and engineering professional associations in EU Member States. These experts will serve on a project-by-project basis with a mandate for excellence in their advice to the Programme.Targeted support of the kind recommended will increase the volume of investment in geothermal energy by established geothermal operators and ensure its more balanced development, both geographically and by encouraging the entry of relative newcomers to the geothermal industry that are presently hampered by the high level of risk of individual geothermal projects. By pooling the risks of several projects, the Programme will mitigate its effects on each one of them and enable a breakthrough for deep-geothermal applications all over Europe with all positive economic and ecological effects.

INSTRUMENT56


Draft GeoRiMi constitutive document 57

The Geothermal Risk Mitigation (GeoRiMi) Fund should be established along the successful model of operation of the European Investment Fund (EIF). This model has proven itself over a period of 15 years. Of course, the scope of operation of the GeoRiMi Fund will be much narrower and so will be its scale of operation.The founding document of the GeoRiMi Fund will be its Statute. It should be modelled on the Statute of the European Investment Fund41. The Statute of the European Investment Fund provides for the drawing up of Rules of Procedure. The model of the Rules of Procedure of GeoRiMi should, also, be the EIF Rules of Procedure42.

The ownership structure proposed by GEOFAR for GeoRiMi is as follows: European Commission 60% European Investment Bank 30% Financial Institutions 10%

The governance structure of GeoRiMi should include: The Shareholders General Meeting The Board of Directors The Chief Executive The Audit Board

Rather than repeat here the detailed provisions of each article in the Statute of the GeoRiMi Fund, the sequel will list <with reasoning> the areas in which GEOFAR proposes to depart from the model:

Task and ActivitiesThe task of the Fund shall be to contribute to the pursuit of European Union objectives in the field of development of geothermal energy.The Fund shall provide guarantees or comparable instruments for loans and other financial obligations in whatever form it is legally permissible. The loans and other financial obligations that will benefit from guarantees by the Fund shall be made for financing capital expenditure solely in the exploratory and drilling stages of geothermal projects.The Fund may engage in other activities connected with or resulting from the tasks set out above. <this provision should cover asset disposals> The Fund shall not engage in borrowing operations <the risk profile of the Fund does not justify any borrowing>The Fund shall finance in part or in whole studies by public (national, regional or local) authorities seeking to develop their geothermal energy potential.

CapitalThe authorised capital of the Fund shall initially be one hundred and twenty million Euros, divided into 240 shares each with a nominal value of five hundred thousand Euros. <the shareholders should review the operation of the fund after the first three years of operation and only then decide whether they want to continue funding it with the remaining 120 million forecast to be needed by the financial projections>The authorised capital may be increased by Decision of the Shareholders General Meeting acting with a majority of 85% of the votes cast.

7. Draft GeoRiMi constitutive document

41 http://www.eif.org/attachments/about/management/EIF_Statutes_30_11_2007.pdf 42 http://www.eif.org/attachments/publications/about/Rules%20of%20Procedure%202009.pdf


SharesThe shares in the initial subscribed capital shall be paid in as to 100% in three equal annual instalments.

Board of DirectorsThe Board of Directors shall consist of seven members appointed by the General Meeting.Members of the Board of Directors shall be appointed for terms of two years, which shall be renewable. <the GeoRiMi fund will run for five yeas or, if terminated early, for three years, but there will be a post-programme year in both cases>

Chief ExecutiveThe Chief Executive shall be appointed for a term of up to three years and shall be eligible for reappointment.

Geographical ScopeThe Fund may conduct its activities in the territory of the Member States of the European Union. <limited scope a better option in the initial stage of operation>

Remuneration of the FundThe level of remuneration or other income sought by the Fund in connection with its activities shall be determined in such a way so as to reflect the risks incurred, to cover the operating expenses, to establish reserves commensurate with the said risks and to generate an appropriate return on its resources.

Limits on the Operations of the FundWith respect to the provision of guarantees, the limits of the commitments of the Fund shall be laid down by the Board of Directors.

Ceiling on the overall Commitments of the FundThe overall commitments of the Fund, excluding commitments made by the Fund on behalf of third parties, may not exceed the amount of subscribed capital.

Cooperation with Third PartiesThe Fund may accept the tasks of administering special resources entrusted to it by third parties, provided that they are compatible with its task, that they are entered in separate accounts and that they are adequately remunerated.The Fund may cooperate with all international organisations exercising their activity in areas similar to its own.The Fund may conclude agreements with such organisations as well as with national organisations and banking partners in the Member States of the Community or third countries with a view to pursuing its objectives or achieving its tasks.

AmendmentsThe Statute can be amended by decision of the General Meeting on proposal by the Board of Directors. Any changes to Articles 2 and 3 of these Statutes shall require a majority of 85% of the votes cast.

Draft GeoRiMi constitutive document58


8. Projected GeoRiMi Financial flows

A simple financial model has been developed to illustrate the workings of the proposed financial support scheme proposed by GEOFAR and aimed at increasing the rate of investment in geothermal energy. The model provides a simplified framework that allows the user of the model to work out the consequences of changes in policy parameters as well as of the assumptions used in building the model for the total amount of support that will be needed and for the rate at which that support will be called upon.The results are provided in the form of tables and graphs, some of which have already been used to illustrate earlier sections.The set of assumptions behind the model are as follows:Average cost of exploratory stage of each project: 1 million €Average cost of production-drilling stage of each project: 10 million € for one geothermal doublet (two

wells)Success rate at exploratory stage: 25%Success rate at production-drilling stage: 35%Time frame of exploratory stage of project: 6 monthsTime frame of production-drilling stage of project: 6 months[Commitment of equity schedule for generating station: one third in each of year 1, year 2 and year 3.]

As with all financial models, this GEOFAR model allows the user to experiment with varying the values of the model parameters. It is straightforward to change the values of the average cost of each project and of the success rates. It is, also, possible to change the time frames assumed for each of the project stages, but not equally easy. Please note that figures than can be readily changed in the model are marked in blue, while others that can be changed, but with care are shown in italics.

The easiest to model are the funds flows for Instrument I:

GeoRiMi FundInstrument I

ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4

ProgrammeYear 5 Total

per study support in € 25.000

number of studies 53 46 40 33 26 198cost in million € 1,33 1,15 1,00 0,83 0,65 4,95

The central assumption is that the number of studies should decline over time, since the clients for those studies should start seeing their value and will be willing to pay for them themselves.

For Instruments II and III we need assumptions on the time profile of projects as follows:

time profile ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4

ProgrammeYear 5

exploratory Total scale factors 20 25 30 35 40 150 100number of projects 13 16 20 23 26 98

time profile ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4

ProgrammeYear 5

drilling Total scale factors 5 7 9 11 13 45 50number of projects 5 7 10 12 14 48

Projected GeoRiMi Financial flows 59


One can specify a scale factor in year 1 and the total number of projects and the model provides a time profile of the rounded number of projects for each of the programme years. The user may vary the number of projects to conform with his or her beliefs as to the speed of project takeup under GeoRiMi. However, GEOFAR believes that the capacity that can be made available EU-wide for drilling cannot much exceed 50 projects in total.

The model assumes a financing profile for an average Instrument II project as follows:

exploratoryunit values in € 1.000.000

equity 40% 400.000guaranteed

loan 60% 600.000

total 100% 1.000.000

And for an average Instrument III project as follows:

drillingunit values

in €10.000.000

equity 33,3% 3.330.000guaranteed loan 66,7% 6.670.000

total 100,00% 10.000.000

Combining the number of projects with the value of guaranteed loans, the model arrives at the following schedule of commitment of guaranteed loans:

total disbursementof guaranteed loans Total Programme

Year 1Programme

Year 2Programme

Year 3Programme

Year 4Programme

Year 5amounts in €

exploratory 58.800.000 7.800.000 9.600.000 12.000.000 13.800.000 15.600.000drilling 320.160.000 33.350.000 46.690.000 66.700.000 80.040.000 93.380.000programme total 378.960.000 41.150.000 56.290.000 78.700.000 93.840.000 108.980.000

One must now assume values for the success rate of the exploratory (Instrument II) and drilling (Instrument III) projects guaranteed under GeoRiMi:

repayment rate baseline current best caseexploratory 25% 25% 65%drilling 35% 35% 75%

The table includes the maximum and minimum values that GEOFAR considers realistic. The user of the model can specify alternative values and readily observe the consequences on the cost of public support, on private investment in the form of equity and debt capital, total investment in exploration and drilling and additional market-sourced investment in generating stations and heat distribution networks.Here is the table for public support:

amounts in € Total ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 2

ProgrammeYear 4

ProgrammeYear 5

Post-ProgrammeYear 1

exploratoryguarantee call rate : 75,00%guarantee call amounts 5.850.000 7.200.000 9.000.000 10.350.000 11.700.000 guarantee call total 44.100.000 drillingguarantee call rate : 65,00%guarantee call amounts 21.677.500 30.348.500 43.355.000 52.026.000 60.697.000 guarantee call total 208.104.000

support total 252.204.000 27.527.500 37.548.500 52.355.000 62.376.000 72.397.000

support total discounted at 5% 203.373.632

Projected GeoRiMi Financial flows60


And here is the summary table for GeoRiMi:

Programme Post-Programme TotalPresent Value

discounted at 5%

Projects started Year 1 Year 2 Year 3 Year 4 Year 5 Year exploratory 13 16 20 23 26 98 drilling 5 7 10 12 14 48

Flows of funds (million €)

Total investment 63,0 86,0 120,0 143,0 166,0 578,0 489,4

Public support 27,5 37,5 52,4 62,4 72,4 252,2 203,4Equity-sourced 21,9 29,7 41,3 49,2 57,0 199,1 168,6Debt-sourced (market) 41,2 28,8 41,2 41,5 46,6 -72,4 126,9 117,4

Additional marketsourced investment

11,1 26,6 48,8 64,3 168,5 319,3 245,0

total investment 897,3 734,4public support/total investment 28,1% 27,7%

The model also generates a table setting out the particulars of the guarantee cycle as follows:GeoRiMi Fund

Guarantees cycleProgramme

Year 1Programme

Year 2Programme

Year 3Programme

Year 4Programme

Year 5Post-

Programme Total

amounts in million €guarantees extended

exploratory 7,80 9,60 12,00 13,80 15,60 58,80drilling 33,35 46,69 66,70 80,04 93,38 320,16total 41,15 56,29 78,70 93,84 108,98 378,96guarantees calledexploratory 5,85 7,20 9,00 10,35 11,70 44,10drilling 21,68 30,35 43,36 52,03 60,70 208,10total 27,53 37,55 52,36 62,38 72,40 252,20provision for guaranteesexploratory 5,85 7,20 9,00 10,35 11,70 44,10drilling 21,68 30,35 43,36 52,03 60,70 208,10total 27,53 37,55 52,36 62,38 72,40 252,20guarantees expiring uncalled at period endexploratory 1,95 2,40 3,00 3,45 3,90 14,70drilling 11,67 16,34 23,35 28,01 32,68 112,06total 13,62 18,74 26,35 31,46 36,58 126,76guarantees outstanding at period endexploratory 7,80 9,60 12,00 13,80 15,60drilling 33,35 46,69 66,70 80,04 93,38total 41,15 56,29 78,70 93,84 108,98guarantees outstanding at period endex called guarantees 41,15 28,76 41,15 41,49 46,60 -72,40



The operation of the guarantees cycles leads to a table showing the revenue from guarantee commissions:

GeoRiMi Fund ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4


amounts in million €total guarantees extended 41,15 56,29 78,70 93,84 108,98 378,96

guarantee fee rate in % 6,00%

total guarantee fees 2,47 3,38 4,72 5,63 6,54 22,74

The results of this table are fed into a table showing the net operating results of GeoRiMi:GeoRiMi Fundrevenue and expense flows

ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4


amounts in million €total guarantee fees 2,47 3,38 4,72 5,63 6,54 22,74Instrument I expenses -1,33 -1,15 -1,00 -0,83 -0,65 -4,95operating expenses -2,00 -2,00 -2,00 -2,00 -2,00 -10,00net operating result -0,86 0,23 1,72 2,81 3,89 7,79

By combining the results of the model so far, one is able to derive the funding requirements of GeoRiMi for each one of its year of operation. The table below shows the schedule of capital contributions:

GeoRiMi Fundcash and capital balances

ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4

ProgrammeYear 5

Post-Programme

Year 1

Post-Programme

Year 2Total

amounts in million €top-up funding capital contributions 1,00 28,00 35,00 50,00 59,00 72,00 -0,58 244,42

cash at period end 0,14 0,84 0,02 0,47 0,98 0,58 0,00 net capital position -27,38 -36,70 -52,34 -61,91 -71,42 0,58 0,00full funding capital contributions 29,00 37,00 51,00 59,00 69,00 -0,58 0,00 244,42

cash at period end 28,14 37,84 53,02 62,47 72,98 0,00 0,00 net capital position 0,62 0,30 0,66 0,09 0,58 0,00 0,00

Two methods of funding are considered. Either the deficit of each year is topped up at the end of each year or capital is provided in time to make up the projected deficit at the beginning of each year.

Projected GeoRiMi Financial flows62


The model also allows the user to calculate the present-value cost of public support in the baseline and other scenarios as specified by the user. Here are the findings in the baseline and the best case:

GeoRiMi Fundsupport flows

ProgrammeYear 1

ProgrammeYear 2

ProgrammeYear 3

ProgrammeYear 4

ProgrammeYear 5

Post-Programme

Year 1

Post-Programme

Year 2Total

amounts in million €baseline top-up funding 1,00 28,00 35,00 50,00 59,00 72,00 -0,58 244,42 full funding 29,00 37,00 51,00 59,00 69,00 -0,58 0,00 244,42 top-up funding discounted 1,00 26,67 31,75 43,19 48,54 56,41 -0,44 207,12

full funding discounted 29,00 35,24 46,26 50,97 56,77 -0,46 0,00 217,77

best case top-up funding 1,00 11,00 14,00 18,00 21,00 28,00 -0,17 92,83 full funding 12,00 15,00 19,00 22,00 25,00 -0,17 0,00 92,83 top-up funding discounted 1,00 10,48 12,70 15,55 17,28 21,94 -0,13 78,81

full funding discounted 12,00 14,29 17,23 19,00 20,57 -0,13 0,00 82,96



Appendix: A high-enthalpy geothermal power plantThis section presents the Pico Vermelho geothermal power plant on the Azores, Portugal. The Pico Vermelho plant is not a heat-generation facility, but an electricity-generating one. One should note the great difference in the scale of capital investment required for electricity generation relative to heat-generation. As a rule of thumb, electricity generation requires four times as much capital as heat generation. However, one must note that the risks of not finding the geothermal resource are equal. Most of the additional capital expenditure required for electricity generation is needed at the later stage of building the power station.The total investment costs for the power plant and drilling of the geothermal wells were 34 million €. The project was financed by the EU and only the power plant by PRODESA (10.3 million €), a regional program and by the EIB (11.0 million €). The remaining investment costs (12.7 million €) were supported by private equity. Insurance was not available for the drilling risk and/or the geological risk. The annual operation costs are approximately 3.5 million €, including personnel (0.6 million €), materials and services (2.9 million €).

Investment Cost

Power plant 20 million €

Drilling of geothermal wells 11 million €

Substation 2 million €

Studies 1 million €

The annual sales sum up to approximately 14.7 million €. The price is established annually and accepted by ERSE (Entidade Reguladora dos Serviços Energéticos); the Portuguese Energy Services Regulatory Authority. Referring to 2009, the price used was 86.7 €/MWhel. The internal rate of return is expected to be 15%, taking into account a non-refundable grant of 50% of the investment cost. These figures confirm the findings in this report calling for significant financial support for public sources, if immediate investment in geothermal energy is deemed an appropriate goal for public purposes.

Figure A-1 The geothermal power plant at Pico Vermelho, Azores, Portugal

APPENDIX 64


IN EUROPEAN REGIONS

Geothermal Finance and Awarenessin European Regions

www.geofar.eu

geofar - emerging financing scheme for fostering investment in the geothermal energy sector

Economy & Finance